The yellow metal has been white hot this year. But those who rush to buy it could still end up in the red.
By Jason Zweig
ILLUSTRATION: ALEX NABAUM
Almost five years ago to the day, a market commentator with a prominent platform called gold “a pet rock.” Since then, gold has risen nearly 70%, hitting an all-time high this week.
That market commentator? Yours truly. How wrong was I, and what can we learn from my mistake?
Oh, was I ever wrong. The yellow metal didn’t sit inert. Since I wrote that column five years ago, gold has returned an average of 10.5% annually—barely below the gains on U.S. stocks. And so far in 2020, it’s up 24% even as stocks are as flat for the year as…pet rocks.
Even so, traders and investors who are perennial fans of the yellow metal have a flaw in their thinking, too. They always believe gold is cheap, no matter what, even though they seldom have the same reasons for believing that it’s cheap. That is its own sort of mistake.
Gold is attracting a lot of money in a hurry. Exchange-traded funds, which had $118 billion in gold assets a year ago, now command $215 billion. One-fifth of all that money has flowed in since Jan. 1, according to the World Gold Council, accounting for nearly half of global demand for gold. In the first half of 2020, gold-backed ETFs lured in a record $40 billion, up from $5 billion in last year’s first half.
Such hot money isn’t always sparked by the same thinking. Depending on what worked at the time, gold has been regarded as a buffer against high inflation, protection against a falling dollar or a universal currency that shines brightest when the news is darkest.
“The factors that drive gold prices tend to fluctuate,” says Suki Cooper, head of precious-metals research at Standard Chartered Bank in New York. “It is a fickle kind of asset.”
In the aftermath of the 2008-09 global financial crisis, investors piled into gold on the belief that low interest rates and trillions of dollars in government spending would ignite hyperinflation and make gold more valuable.
Gold shot up close to $1,900 in the summer of 2011, but the hyperinflation never materialized. In real, inflation-adjusted terms, gold gained about 6% annually in both 2011 and 2012, then lost 38% from 2013 through 2015, according to Christophe Spaenjers, a finance professor at the HEC Paris business school in Jouy-en-Josas, France. By late 2015 the gold price had sagged to $1,050.
Gold is, in fact, a poor hedge against inflation. Accounting for changes in the cost of living, gold has returned an average of minus 0.4% annually since 1980, versus positive annualized returns of 7.9% for U.S. stocks, 6.2% for U.S. bonds and 1.2% for cash, according to Prof. Spaenjers.
Adjusted for inflation, he reckons, gold would still have to rise approximately 52% from this week’s prices to match its level of January 1980. That is when it peaked in inflation-adjusted terms.
So you hear less about gold’s purported inflation-fighting powers nowadays. Instead, fans argue the dollar is losing value and, above all, that low interest rates in the U.S. and negative rates elsewhere will drive gold higher.
That makes some sense. It costs money to store and insure gold, which—unlike cash or bonds—produces no income. When the return on cash is nil or negative after inflation, gold’s income disadvantage disappears. Investors then become more willing to “look to assets where the value will at least be retained, which benefits gold,” Ms. Cooper says.
Although I expected interest rates to stay low for a long time, I never thought they would go this low, with even 30-year U.S. Treasury bonds yielding less than 1.3%. Such low rates have fueled high returns for gold.
So the yellow metal, once considered a hedge against an overheated economy, has become a bet against a return to economic growth.
That’s not a sure thing. “The main downside risk to gold is that interest rates may not remain low for a prolonged period,” says Ms. Cooper. A surprisingly swift or unexpectedly strong economic recovery could push interest rates back up, hurting gold.
Another risk: The hot money that has poured in lately might turn out to be even more fickle than the precious metal itself. Just ask anybody who bought gold in 1980 around $850, when speculators lined up on city sidewalks to get their hands on the stuff. By the end of 1981, gold was back under $400.
As I said five years ago, there’s nothing wrong with keeping a few percentage points of your portfolio in gold. That’s especially true if you build that position over time and hold it as lifelong insurance against a collapse in the dollar or as a long-term hedge against low interest rates.
Then, even if gold reverts to being a pet rock, you shouldn’t regret holding it; after all, the purpose of insurance isn’t to obtain high returns, but to protect against risks.
If, however, you’re buying gold by the fistful now that it’s surged in price and popularity, then you run a substantial risk of ending up being as wrong as I have been.
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