Gold has been on a roll lately. After peaking at almost $1,900 an ounce in 2011 the precious metal endured a severe bear market and bottomed at $1,051 in 2015. In 2016 it posted its biggest quarterly gain in decades during the first quarter (up 16.5%) and recently traded at $1,347 per ounce. It is up around 27% year to date. Reasons for the rally include low and negative interest rates which make the opportunity cost of holding gold negligible and increased levels of geopolitical uncertainty.
APCM does not hold gold as a stand-alone investment for clients. Many client portfolios do own a commodity Exchange Traded Note (ETN) that has exposure to the energy, agriculture and metals markets (including gold). Within asset allocation accounts commodities provide diversification benefits and are a hedge against unexpected spikes in inflation.
The allure of gold has existed for millennia as humans have long valued both its beauty and rarity and found uses that range from jewelry to a simple store of value. Gold mining has been in practice for more than 6,000 years and during that time it is believed that roughly 170,000 metric tons has been extracted. While that seems like a lot, that amount would fit inside four Olympic swimming pools. For comparison, based on 2015 output levels, the world produces more steel in one hour than all the gold that has ever been mined.
Demand for gold comes from jewelry, industrial and technological applications, central bank reserves, and also as an investment. In so far as supply goes, there are not a lot new gold discoveries and according to State Street the “all in costs” of bringing gold to market are close to where prices are today – around $1,200. That’s important because if prices fall, supply will be shuttered, thus bringing supply and demand into balance quickly.
If you are buying gold as an investment you probably are (1) concerned about inflation risks or (2) worried about a breakdown of society and/or all hell breaking loose in the markets. Thus gold is a kind of insurance in portfolios against bad stuff happening. It is a “safe haven” asset.
It does have its drawbacks including that it generates no income and there are storage and insurance costs associated with holding physical gold. It is also hard to value as an investment (no cash flows to discount!) and long term returns (while keeping up with inflation) are quite inferior to traditional equities.
The chart below shows the performance of gold (white line), the S&P 500 (orange line) and inflation (yellow line) since 1947 on a price basis only. Since stocks pay dividends you can add 2 to 3% to the annual return of the S&P 500 and thus the total return is closer to 10%. Gold comes in at 5.25% before expenses (i.e. storage and insurance which total about 0.40% per year) and 4.85% net of fees. Inflation over the period ran at 3.5%. While recent history shows gains from gold did beat the rate of inflation, and gold can provide some comfort during times of market stress, ultimately there are better alternatives for earning long term returns.
Nicholas Case, CFA®
Senior Investment Analyst