Many investors consider gold as a relatively low-risk and safe haven asset class, with certain advisors recommending investments in gold as a core-part of an investment portfolio due to it’s perceived safe-haven status.
The typical arguments for holding gold as part of your investment portfolio include:
- Hedge against Inflation / Storage of value: gold is often seen as a hedge against inflation and that gold prices move up when inflation is high
- Hedge against Excessive Money printing: since there is a finite supply of gold, gold prices are expected to rise when the supply of money rises sharply
- Hedge against home currency depreciation against the dollar: since gold is priced globally in dollars, a depreciation of the rupee will lead to an increase in gold price in Rupees (even if the prices are stable in dollar terms)
Gold is actually a highly risky asset-class
If you study the actual longer-term price movements of gold, you will see that gold prices actually display a much higher degree of volatility than traditional asset classes and that their cycles are both longer & more unpredictable than other asset classes. This very high degree of volatility & unpredictability make it actually a highly risky asset-class (as compared to the safety often associated with gold).
Additionally as the longer-term data shows, the typical arguments for holding gold work in some (but not all) circumstances, which makes predicting gold price movements inherently challenging.
Additionally as the longer-term data shows, the typical arguments for holding gold work in some (but not all) circumstances, which makes predicting gold price movements inherently challenging.
Gold is technically not considered an 'asset' and cannot be valued
In finance, all assets have the ability to generate a stream of cash flows (interest in bonds, rent in real estate, dividends in equity). These cash flows can be discounted back to the present value, to arrive at an 'intrinsic value' of that asset. Since gold does not produce any stream of cash flows, it does not technically have an 'intrinsic value' - a key element behind the very high degree of longer-term volatility & unpredictability in gold prices.
Studying Longer-term Gold Price movements
An analysis of longer-term price movements in gold (data over the last 50 years from 1973 to 2022), the very high degree of volatility & unpredictability of gold prices immediately becomes apparent. We break this long 50-year period, into 5-distinct bull & bear periods that clearly emerge.
1976 - 1980 Bull Market (Gold prices increased 5.3x in a mere 5 years)
The late 1970's saw a very sharp rally in gold prices, on the back of consistent high inflation through the 1970s (caused by high oil prices, post the Iranian revolution). This huge rally in gold prices, at a time of high inflationary pressure, is what drove gold's perception as a storage of value & a protection against inflation.
1980 - 2000: a 2-decade Bear Market (Gold prices down 63% over 20 years)
Post the sharp rally in gold prices, gold prices saw a sharp bear-market that lasted for over 20 years. From the peak of $691/ounce in the 1980's, gold prices fell to $255/ounce in 2020. Interestingly, even if you had bought gold prices after gold prices bottomed post that sharp correction in 1985 ($300/ounce), you would still be down 15% after 15 years (despite having bought after the sharp correction).
Importantly, this 20-year period had it's fair share of uncertainties (periods when gold prices are expected to rise sharply & behave as a 'safe-haven'. This includes the Asian currency crisis, Russian & Latin American debt defaults, the dot-com crash, the 1991 Gulf War and record low interest rates (that caused the sub-prime housing bubble).
Importantly, this 20-year period had it's fair share of uncertainties (periods when gold prices are expected to rise sharply & behave as a 'safe-haven'. This includes the Asian currency crisis, Russian & Latin American debt defaults, the dot-com crash, the 1991 Gulf War and record low interest rates (that caused the sub-prime housing bubble).
2000 - 2011 Bull Market (Gold prices increased 7x in 11 years)
Post a 2-decade stagnation, gold prices rallied a sharp 7x in 11 years. This bull market can be broken up into 2 distinct phases:
(a) the rally from $255 to $915 from 2000 to 2008: This rally took place in a period of very strong global asset prices. There were no major concerns around inflation, wars, currency printing or any of the other typical reasons that are typically associated with gold prices moving up.
(B) Post sub-prime rally from $915 to $1800 from 2008 to 2011: Driven by aggressive money printing by global central banks, in response to the global sub-prime crisis. In this period, gold did indeed act as a 'safe-haven' asset.
(a) the rally from $255 to $915 from 2000 to 2008: This rally took place in a period of very strong global asset prices. There were no major concerns around inflation, wars, currency printing or any of the other typical reasons that are typically associated with gold prices moving up.
(B) Post sub-prime rally from $915 to $1800 from 2008 to 2011: Driven by aggressive money printing by global central banks, in response to the global sub-prime crisis. In this period, gold did indeed act as a 'safe-haven' asset.
2011 - 2016 Bear Market (40% decline over 5 years)
Post peaking at $1800, gold prices fell a substantial 40% over 2011 to 2016, making this one of the worst performing asset classes over this period. A 40% decline in a short 5-year time span (in recent history), clearly showcases the risk & high volatility of gold (as compared to it's perceived safe haven status).
2016 - 2020 Bull Market (Gold prices increased 85% in 4 years)
Post the sharp 2011-2016 correction, gold prices started to rally in 2016 off their $1050 lows, peaking at $1957 in 2020. Again the large part of this rally (from $1050 to $1650) took place before the outbreak of the COVID crisis and without any of the typical identifiable factors attributed to rising gold prices - inflation, money printing and market sentiment were all positive over this period.
Interesting, this bull market stagnated in Jul-20 during a period of very high COVID related uncertainty and an unprecedented level of money printing & fiscal spending. Gold should typically have continued to rally in this period of high money printing & uncertainity, but failed to do so.
Interesting, this bull market stagnated in Jul-20 during a period of very high COVID related uncertainty and an unprecedented level of money printing & fiscal spending. Gold should typically have continued to rally in this period of high money printing & uncertainity, but failed to do so.
Conclusion - Gold is a risky & unpredictable asset-class
A study of the longer-term price cycle of gold, draws the following conclusions:
- Unpredictable length of bull & bear-cycles: Bond, equity & real-estate cycles, are typically directly linked to the economic cycle and have more predictable lengths of a complete cycle (bull + bear). Gold historically has shown no clear linkage to an economic cycle and the length of the cycles are completely unpredictable.
- Gold does not behave as often expected (to inflation, money printing, wars): As can be seen multiple times in the past, where gold did not react as expected. This includes the 1980-2000 bear (where gold prices remained weak despite many uncertainties), the 2000-2008 rally (where gold prices rallied sharply despite no major concerns), the 2011-2016 correction (worst performing asset class over this period) and the rally from 2016 to Feb-20 (without any specific concerns on the horizon).
- Higher Volatility that other asset classes: Longer-term gold prices have actually demonstrated substantially higher volatility than either equity or real-estate (both asset classes that are typically considered riskier than gold).
- No intrinsic value: The lack of a stream of cash flows that allows for a calculation of an ‘intrinsic value’, effectively makes gold prices highly speculative in nature.
We do not recommend Gold as a long-term structural investment
Given the high level of unpredictability & volatility of gold prices, we see gold more as a 'trading-play' where tactical allocations can be taken at times when gold prices are expected to move up. However, given the sharp de-linking of gold prices to typical factors associated with gold prices moving up, such tactical allocations also come with a high degree of risk.