What the Gold Rally Means for Investors
Although markets have performed well this year, some investors may be nervous about upcoming events such as the presidential election, the Fed's next rate decision, and the state of the economy. Along with the uncertainty of the past few years, it's no wonder that gold prices have also risen to record levels above $2,600 per ounce.
While gold can serve many important purposes, some investors may focus on it as a standalone investment rather than a well-constructed portfolio component. What role should gold play in long-term investment and financial plans in today's market environment?
There are many reasons investors are drawn to gold. Many look to it as a store of value, especially in inflationary periods such as the one we just experienced. Others turn to gold during political and global uncertainty, particularly as a hedge against fiscal deficits and loose monetary policy.
It can also safeguard against market volatility when geopolitical risk is heightened, as is the case today with tensions in the Middle East.
While gold can play these roles, the stock market has historically outperformed over long periods. However, understanding the relationship between gold and other asset classes is critical as markets continue to rally.
Gold and stocks can behave differently across market environments
The case for gold depends on the portfolio objective. Across economic environments, gold can serve at least two investment purposes. First, as a precious metal with consumer and industrial uses, the value of gold can rise over time due to limited supply and steadily increasing demand.
This is in addition to the demand for gold as a luxury good. As a result, it can serve as a store of value when the world is uncertain and can also protect against inflation as the economy heats up or as central banks increase stimulus, as they have done this year.
It's also clear that many investors flock to gold for safety when markets get choppy. In many ways, this is no different from how some investors view cash or bonds - as a tool to protect their portfolio from short-term market swings. However, unlike cash and other safe-haven assets, gold does not generate any portfolio income.
The second and more important consideration is whether gold can help diversify portfolios, as gold tends to perform differently from stocks. The relationship between gold and the stock market, shown in the accompanying chart, makes this clear.
Although gold outperformed stocks during the global financial crisis, it fell in value and flat-lined for years while the stock market climbed to new record highs. Gold also jumped in value during the pandemic and again more recently as the Fed began to cut rates.
What may be surprising is that gold was relatively flat during the recent inflationary period that began in 2021. This is partly because the Fed raised rates rapidly in 2022, increasing the attractiveness of cash and other short-term assets. This shows that understanding the underlying drivers of gold price movements and Fed policy is essential when making portfolio decisions.
It's also important to note that the stock market outperformed gold over this entire period. Of course, constructing a portfolio is not just about investing in the best-performing asset – it's about diversifying to create a smoother ride and to meet financial objectives. So, while gold may be attractive to investors for a variety of reasons, it's always important to view it with respect to other important asset classes.
Falling interest rates can make gold more attractive
Why have gold prices risen recently? Gold tends to perform well when interest rates decline since lower rates on bonds and cash make gold, which provides no yield, more attractive on a relative basis.
Specifically, the Fed tends to cut rates to spur economic growth, which can result from an economic slowdown and can also be viewed as inflationary. Both scenarios can be positive for gold as a store of value and hedge against rising prices.
While gold has experienced a strong rally and is hovering near all-time highs, keeping its relative performance in perspective is important. Gold prices are now hovering around record levels, but the choppiness of gold prices over the past few years shows that while it can act as both a hedge during inflationary periods and serve as a store of value, this can reverse quickly as conditions change.
Many other assets have performed well this year
Like all asset classes, gold is most valuable as part of a diversified portfolio rather than as a standalone investment. The accompanying chart shows that many asset classes, including international stocks, small caps, and more, have contributed to the performance of broad market indices this year.
Geopolitics, the election, and other investor concerns will continue to drive markets. Rather than focus on individual asset classes, it's more important for investors to construct portfolios that can withstand evolving market conditions.
Ideally, this should be done with the guidance of a trusted advisor. History shows that while investor worries come and go, the principles of long-term investing remain the same.
The bottom line: Gold's recent rally can be attributed to Fed rate cuts, geopolitical tension, and fiscal concerns. Investing in gold or any alternative asset should be considered in the context of a well-diversified investment strategy rather than as a standalone investment.
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Matt Faubion, CFP®
Founder - Wealth Manager
This article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, accounting, and financial professionals if you want more information. This content is developed from sources believed to be providing accurate information, and provided by Copyright (c) 2024 Faubion Wealth Management LLC, and Clearnomics, Inc. All rights reserved. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.