Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
The price of an ounce of gold rose through $2,000 this week for the first time ever. Its previous peak of around $1,900 an ounce was struck in 2011 so this is a significant multi-year event - what does it mean and what should you do now?
First, let’s put the recent rise into perspective. Gold has risen by about a third since the start of the year. Dwarfed only by silver, which marches to a slightly different drumbeat to gold, the yellow metal has been one of the best investments in the year to date.
But look further back and the scale of gold’s ascent becomes even more obvious. The price has nearly doubled in the past five years. Over the past two decades, it has risen around eight-fold. Gold is more popular with investors than ever. Please remember past performance is not a reliable indicator of future returns.
There are many reasons why investors choose to hold gold and today’s environment provides something of a perfect storm of these.
Gold is perceived to be a reliable store of value, especially during difficult times. In part this is a reflection of its scarcity. Unlike paper money, which can be printed at will by a government in need of cash, gold is a finite resource. All of the metal ever mined would fit in just a few big swimming pools.
That is the long-term case for holding a small proportion of any portfolio in gold. It is a kind of insurance policy.
In the shorter-term, there are a number of reasons why gold should be rising now.
The first is the fact that the US dollar, the currency in which gold is priced, is weakening today. The generally accepted reason for this (no-one really knows why currencies move up and down) is that expectations for US economic growth are falling. This in turn leads to the expectation that interest rates and bond yields will remain low or fall further. This further suggests that demand for holding the dollar will decline and hence its value.
A lower dollar is good news for the gold price because it makes buying an ounce of gold in another currency cheaper and so more attractive. It will cost fewer pounds, yen or euros to buy the same amount of gold.
Low bond yields support a higher gold price for another reason. Because gold does not pay investors an income, it is a costly luxury to hold it when interest rates and bond yields are high. You are effectively giving up a significant income by parking your money in bullion rather than in a deposit account or bond. If rates and yields are low, however, the opportunity loss is much lower too. There is less incentive not to hold gold when you can earn so little elsewhere.
And it is not just the absolute level of yields that matters but their level in real, inflation-adjusted terms. If inflation rises above the level of bond yields, their real value becomes not just low but potentially negative. In many cases this is true today and the incentive to hide in gold is commensurately higher still.
Inflation expectations are rising because of the extraordinary measures that governments and central banks have taken in recent years (and particularly since the outbreak of the Covid-19 pandemic) to support economies by printing money to support the jobs market, underpin financial markets and generally boost activity. So, while there is little evidence that inflation is a problem today, it could become one soon and gold buyers are moving in anticipation of that.
So, the obvious question now is whether gold is still an attractive investment after its recent strong rise. This is a difficult question to answer because unlike other investments there are no obvious measures (such as a dividend yield or price-earnings ratio) with which to compare gold’s appeal against other assets or indeed its own price history. Investing in gold is essentially an act of faith.
However, from the factors already discussed, it is clear that there is a connection between the gold price and real, inflation-adjusted bond yields. For the price of gold to go further it is likely that we will need to see a further fall in real yields, which will only be achieved by either falling nominal yields on the back of sluggish growth or rising inflation, or both. What we used to call in the 1970s stagflation.
This was the bet that investors were making the last time gold spiked higher in 2011. The Federal Reserve was then, as it is now, printing money to support the US economy. At the same time, growth was sluggish as we emerged slowly and tentatively from the financial crisis. Stagflation seemed a reasonable assumption at the time and investors flocked to the safety of gold.
Unfortunately for them, inflation failed to show up as expected. Growth improved as the Eurozone sovereign debt crisis receded and the price of gold fell by almost half.
So, following the herd into gold today is not without significant risks. It is possible that it continues to rise. History does point to multi-year cycles in the gold price and big overshoots in both directions. But it is also possible that its popularity today is a reflection of extreme fears about Covid-19 which may evaporate in due course, if, for example, a vaccine is found.
If you do wish to invest in gold, what is the best way to do it? You have several choices. You can actually buy the metal itself, as a bar or in the form of coins or jewellery. This has some drawbacks because you should also factor in the cost of protecting your gold from theft or loss.
An alternative way of investing in gold itself is via a fund that invests directly in the metal. The simplest way of doing this is via an Exchange Traded Fund such as the iShares Physical Gold ETC. This features on Fidelity’s Select ETF list and scores well on our experts’ measures and has the added benefit of investing in real, physical gold so it involves no counter-party risk with another investor.
The third way to benefit from a rising gold price is to invest in the shares of gold miners. These can be a good way of capturing the upside in the gold price because a miner will have relatively fixed costs, enabling a rise in the price of the metal to have a disproportionately big impact on its profits. The Ninety One (formerly Investec) Global Gold Fund features on our Select 50 list of favourite funds.
Five year performance
|(%) As at 4 Aug||2015-2016||2016-2017||2017-2018||2018-2019||2019-2020|
Past performance is not a reliable indicator of future returns
Source: FE, S&P GSCI Gold spot returns as at 4.8.20, in local currency
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.