The Case for an Allocation to Gold
A compelling argument can be made for most investors to allocate some percentage of their portfolios to gold from time to time. Several factors support this recommendation, including:
Inflation
Gold has historically served as a long-term hedge against inflation. The supply of gold, along with other “real” assets like land, is finite. Consequently, its price tends to increase when measured in paper currencies, which have a continuously expanding supply. Paper currencies are commonly known as fiat money, as they can be generated at the discretion of governing authorities. The supply of gold experiences only gradual growth as new reserves are extracted from the earth. There was a significant increase in global inflation in the years following the onset of the COVID pandemic. Supply chains were disrupted, and governments acted to bolster demand by increasing their money supplies. In the United States, the money supply (measured by M2) grew by approximately 40% from 2019 to 2022, primarily to offset the slump in economic activity due to COVID. Although this growth has recently decelerated and turned negative, the money supply remains far above its long-term trend.
Geopolitical Stress
Gold historically performs well during periods of crisis and geopolitical turmoil. With war in Ukraine and the Middle East, as well as concerns about escalating tensions with China, it is conceivable that one or more of these may escalate into a broader regional conflict.
Hedge Against Dollar Weakness
Gold, priced in dollars, tends to appreciate when the dollar weakens. The U.S. dollar has maintained its strength against other major global currencies in recent years. If this trend were to reverse, the price of gold would likely rise. In recent years, the BRICS nations have attempted to reduce their reliance on the U.S. dollar, seeking to have trades for commodities they produce settle in other currencies. The BRICS have also expressed concern over America using the dollar as an economic weapon against them.
Historical Role as Money
Gold has outlasted every form of paper currency and has been recognized as a form of money throughout most of human civilization. Recently, Bitcoin has been referred to as a new “digital gold.” Time will tell whether Bitcoin can endure and attain a comparable level of acceptance. Over the past few years, the surge in Bitcoin’s price might have detracted from the demand for gold.
Central Bank Reserves
Each central bank around the world maintains a portfolio of assets including various paper currencies and gold. During the latter half of the 20th century, central banks typically favored paper currencies–fiat money–over bullion and decreased the percentage of their portfolios allocated to gold. In recent decades that trend has been reversing, particularly among the emerging economies that represent an increasing portion of global wealth. They are buying gold aggressively.
Positive Price Trend
Gold recently reached a new all-time high of $2,100 per ounce. It has made a considerable price advance since the year 2000, when it was trading at only $250 per ounce. It may come as a surprise to many that gold has been one of the top-performing assets of the 21st century, even outpacing the return of the S&P 500 Index during this period. An even larger price gain occurred in the 1970s after the U.S. decoupled the dollar from gold.
Diversification
Gold is an excellent portfolio diversifier. This is especially true when exogenous events occur that push down stock prices materially. As the table below shows, bonds and gold have provided varying degrees of protection during these periods. Gold and bonds together can serve a very important role protecting portfolios during periods of negative equity returns.