There is a common saying that time heals almost everything. Yet, even as we embark on the fifth year since the pandemic began, most of
Should You Go for Gold?
Published Date : March 17, 2014
Few asset classes performed more poorly than gold in 2013. But with the recent run-up in the precious metal into the start of 2014, investors are asking: is now the time to buy? Before you start stocking your basement with bullion, however, let’s take a look back at gold’s history.
Gold is notorious for long booms and busts. After a decade-long rally, gold reached an all-time high of $1,922 on September 6, 2011. Gold then went on to lose more than a third of its value over the next two years – losing 28% in 2013 alone. The story was no different in the 1970s and 80s when the yellow metal spiked after the end of the gold standard, only to plunge right back down for the next two decades: yet another extra-long rally and crash.
These momentous ups and downs wouldn’t be an issue if we could plan accordingly, but unfortunately gold is also incredibly difficult to value and predict. To value many assets, we look to expected cash flow, but gold doesn’t generate any cash and even costs money to store. For a stock we might compare its price-to-earnings ratio to that of the market, but gold has no earnings. With many seeing gold as a safe haven asset, you might expect gold to move in lockstep with Treasuries (an asset we might feel more comfortable predicting), but correlations for the two are all over the place, sometimes even negative. In fact, correlations of gold to most asset classes are non-existent making the predictive power of other assets somewhat useless. Even predicting the demand for gold – driven by everything from inflation expectations to investor fear to Indian wedding season – requires a crystal ball rather than an analytic model to figure out. And after all of gold’s marathon booms and busts, the real long-term return from the precious metal is about the same as a US T-Bill (depending on when it was purchased), but with a lot more volatility.
But perhaps gold holds a place in the portfolio as a hedge against potential inflation, particularly with the current environment of ongoing tapering and rising interest rates? If we look back at the past 25 years, there is little statistically significant evidence for a relationship between the change in gold price and the change in 1-year forward inflation expectations. Some evidence alludes to the fact that there may be a correlation between gold and inflation over the very long-term, but taking advantage of it requires excellent market timing. While gold served as a decent inflation protector in the 1970s, the relationship only held if you got into gold at the right point and got out of it at the right point. Further, we expect headline inflation to remain remarkably stable at 1.5-2%, mitigating the need for such a hedge.
While gold has seen some positive action as investors piled into the safe haven metal at the start of 2014, we continue to believe the bust of gold’s notoriously long boom-bust cycle is still far from over. Further, as the Fed continues to taper its bond purchases, the attractiveness of gold versus other safe haven options will diminish putting further downward pressure on prices. With higher interest rates, investors will be more inclined to put their cash into Treasuries or CDs where they can now be earning risk-free yield. Given our macroeconomic outlook of a continuing moderate recovery and rising interest rates, we expect gold, and precious metals in general, to continue to face headwinds in 2014.
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