Could Gold Be the Key to Protecting Your Wealth in Uncertain Times?
By Zeke Anders on September 19, 2024
Gold has been used as a store of wealth for thousands of years. The oldest gold artifacts in the world were found in Bulgaria and were created around 4,600 to 4,200 BC1. Gold has been used as a currency and as a reserve asset for thousands of years. Gold has some commercial uses as well. Gold is the most malleable metal and resists corrosion. That said, the value of gold is perhaps more closely tied to it’s value as an investment and store of wealth.
Before we had “money”, people bartered goods and services. If you had eggs and needed wheat, you’d need to find someone with wheat that wanted eggs, or trade your eggs for something that someone with wheat wanted. You can imagine how this process would be inefficient. It makes sense that people gathered in “markets” to make these exchanges, having more people around with many different goods increases the odds that you’ll find someone who has what you need and someone that needs what you have. It would be more efficient, though, to have a single commodity that everyone can use to trade. Instead of finding someone with wheat that needs eggs, you just sell the eggs for a universal commodity and use that same commodity to buy wheat. This universal commodity is money.
Many things have been used as money throughout history. In Mesopotamia, a shekel represented 160 grains of rice2. Several civilizations used shells3. Paper currency started in the Song dynasty in China, between 960 and 12794. And of course, many civilizations used gold. Textbooks ascribe three functions to money; a medium of exchange, a unit of account, and a store of value. Practically speaking, you want everyone to agree that your money is valuable, and you want it to maintain it’s value. Using perishable goods as “money” would not work because they could be spoiled before you need to use them. Using something very heavy would have been hard to move before trains and cars were invented. Using something that is difficult to divide would be challenging too. Imagine if you needed one pound of wheat, but only had an indivisible unit of money worth 100 pounds of wheat. Gold met these requirements because it is easy to divide, which makes it light enough to carry, it resists corrosion, and it is non-perishable. It is also scarce. Gold had to be found or mined. Scarcity can help maintain value, assuming there is demand.
Gold has drawbacks too, however. Though it can be divided, large amounts of gold are heavy. The limited supply can be a downside at times. Mining gold is a difficult, dirty, and disruptive process. Nevertheless, gold was used as a currency itself for many years, and was still the basis for the money supply in the U.S., on and off, until 1971. We’re not going to get into why the U.S. left the gold standard, which would require a much, much longer post. What is relevant for this piece, is that leaving the gold standard de-coupled the value of the U.S. dollar from the amount of gold in reserves.
Today, many households and investors see gold as a hedge against inflation. Because it is harder to increase the supply of gold, whereas it is easy to “print” dollars, the theory is that gold will be a more stable store of value. It is easy to see the value that investors ascribe to gold for this function.
1 https://en.wikipedia.org/wiki/Gold#Culture
2 https://en.wikipedia.org/wiki/Money
3 https://en.wikipedia.org/wiki/Shell_money
4 https://en.wikipedia.org/wiki/Money, https://en.wikipedia.org/wiki/Song_dynasty
Per Barrick, a major gold producer, their cost of production per ounce of gold is $940-$1020, according to their April 2024 fact sheet. Their total cost of sales is $1,320-$1,420 per ounce5. The price of an ounce of gold, per Kitco as of July 31, 2024, is $2,450.80 per ounce. This reflects a ~72% premium over the cost of sale.
Gold’s record as an inflation hedge is mixed. In 2022, when inflation spiked, the return of GLD, an ETF that holds physical gold, was -0.77%6, per Morningstar. Granted, that is not bad compared to SPY, an ETF tracking the S&P 500 which was down 18.17%7, or AGG, an ETF that tracks the U.S. bond market, which was down -13.02%8. That said, gold did not perfectly hedge inflation. Gold may keep up with inflation better over longer time horizons, but in the short term it may not.
Source: U.S. Bureau of Labor Statistics, as of July 31, 2024
5 https://www.barrick.com/English/investors/default.aspx
6 https://www.morningstar.com/etfs/arcx/gld/quote – as of 12/31/2022
7 https://www.morningstar.com/etfs/arcx/spy/quote – as of 12/31/2022
8 https://www.morningstar.com/etfs/arcx/agg/quote – as of 12/31/2022
Source: Bloomberg, as of 8/9/2024
Source: David Bahnsen’s Dividend Café, as of 8/5/2024
Gold is also sensitive to interest rates, which also spiked in 2022. Gold, of course, has no cash flows. Interest rates before and especially during the pandemic were low. When interest rates are low, the opportunity cost of holding gold is lower. For example, if the yield on a savings or money market account is near zero, you might not mind that gold doesn’t have a yield because neither does anything else. However, when interest rates increased to 5.25%, there was a real cost to holding gold.
Source: Federal Reserve Bank of St. Louis, as of July 31, 2024
There’s also an opportunity cost to holding gold versus investing in the stock market. When fear is high, investors may retreat to gold, such as during and after the Great Financial Crisis. When the stock market is rallying, however, investors may leave gold to jump into stocks, such as from 2012 to 2020 in the chart below.
Source: Morningstar, as of July 31, 2024
As the chart shows, gold can experience prolonged drawdowns, despite it’s reputation as a store of value. The value of gold is tied to supply and demand, which shifts with investor sentiment.
Gold can add value to portfolios as a diversifying asset. Gold has a low correlation with U.S. large cap stocks, meaning that a change in equities does not directly affect the price of gold or vice versa, the assets move independently of each other. Having some uncorrelated assets in your portfolio can reduce the overall volatility of your portfolio, but it requires patience when one asset is underperforming. It is tempting to invest more in assets with strong recent performance, and sell assets that have lagged, but to capture the benefits of diversification sometimes you need to keep the laggards or even rebalance and invest more into them. Not every investor will have the patience to stick with an investment with an 8-year drawdown like gold from 2012-2020.
Gold has a long, storied history. Different civilizations all over the world have used gold as a currency for thousands of years. While it has some practical uses, the value of gold is more closely tied to the belief that is valuable, and the demand for gold as a store of value. Gold has a low correlation with equity markets and can sometimes rally when investors are fearful. That said, it can also go through prolonged periods of negative or low returns. It may keep up with inflation over longer time horizons, but may not over shorter periods. It is important to be clear-eyed about the role gold plays in your plan and asset allocation, and of the opportunity costs that may come with it.
