What Investors Miss About The Price Of Gold, And Where We Stand Today

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One kilogram gold bars at a mint refinery.

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Key Takeaways

  • Gold should be looked at as a store of value and not as a long-term investment.
  • Investors need to look at the entire landscape and not one or two economic indicators to determine the future value of gold.
  • Know the drawbacks of owning physical gold versus buying gold ETFs, you can find a list of topflight gold ETFs below.

Gold is a valuable resource that humans have coveted for centuries. Though the price of gold can be volatile at times, it is widely regarded as a safe, smart investment. But this doesn’t mean it is the right fit for every portfolio. There are a few things to remember for those looking to invest in gold, and a few misconceptions that every investor should be aware of.

Why Is Gold Valuable?

Gold is scarce. It’s also difficult to mine, and it’s tough to argue with that shiny luster. In addition, gold does not corrode, so you can store it for the long term. Before gold was turned into coins, people traded gold nuggets. As economies and nations evolved, many countries used gold to build confidence and back paper currencies.

Even though no country is on the gold standard today, many countries still hold large reserves of gold in case of economic collapse.

When is Gold a Good Investment?

Because of the intrinsic value of gold, you might think that buying gold is a good investment. Since there is a significant demand for gold, the price should rise, earning you a healthy return. But the price of gold doesn’t always increase. Like other commodities, stocks, and bonds, the price fluctuates due to various factors, detailed below.

The most important thing investors need to understand about gold is that it needs to be seen as a store of value and not purely as an investment like a stock. For example, you buy a stock based on future growth and earnings. If a stock is trading at $20 today and in ten years you expect the company to grow 100%, then you would also expect the price of the stock to grow 100%. In this case, you would turn your $20 into $40.

Gold doesn’t act this way. There are no future earnings or growth prospects. As a result, investors need to see it as a store of value. In other words, you invest in gold to retain your purchasing power.

Look at inflation as an example. When inflation increases, the purchasing power of the money you have decreases. With a 10% inflation rate, something that costs $1.00 will now cost you $1.10. You need more currency to buy the same goods. Since gold holds its value, you can offset the loss of purchasing power of your dollars by investing in gold.

What is the Price of Gold Correlated to?

Now that you understand that gold is a store of value, you might wonder how the price of gold reacts to various economic conditions. Here is what you can expect.

Gold Price Correlation to Recessions

In the past, gold prices and recessions have had an inverse relationship. When the economy weakens, gold prices usually increase as investors flock to the mainstay of all safe-haven assets. During the last three recessions, 2020, 2007, and 2001, the price of gold increased while the value of the S&P 500 decreased.

However, an investor shouldn’t assume that the price of gold will always increase during a recession. During the recession in 1980, gold dropped by 5%. The moral here is you need to look at the entire economic picture and not one or two indicators to decide if gold is a smart option for your portfolio.

Gold Price Correlation to Inflation

When inflation is on the rise, gold prices usually follow suit. This is because investors see gold as a hedge against inflation. As paper money loses value, gold becomes a more valuable asset.

With that said, some research has shown that gold sometimes performs poorly during higher inflationary periods. For example, 1980-1984, gold prices fell 10% while inflation was around 6.5%. Between 1988-1991, gold fell 7.6% while inflation was 4.6%.

This has led some experts to say gold is not a hedge against inflation. The problem with this analysis is that the researchers only looked at the inflation rate and the price of gold, not the entire economic picture. Let’s look at the years 1980-1984 in more detail.

The US economy was in a deep recession, and inflation was high. But President Reagan cut taxes and eased government regulations in 1980. He also cut government spending on social programs and increased military spending. The result was the S&P 500 gaining close to 26% that year, followed by a loss of 10% in 1981. Then in 1982 and 1983, it gained 15% and 17% respectively.

Even though there was a recession and high inflation, the stock market was performing well, and Americans had more money in their pockets from the tax cuts. As a result, there was not a strong demand for gold.

Gold Price Correlation to Interest Rates

Many believe that gold and interest rates have an inverse relationship.

When interest rates rise, gold prices often fall because investors will flee from gold, buying up bonds and other low-risk investments now that they have a higher effective yield.

But history has shown that in most cases, there is a positive correlation between gold and interest rates, meaning when interest rates rise, so does the price of gold.

The most recent occurrence of a negative correlation was between 2008 and 2015 when interest rates were low, and the price of gold was rising. Looking at the bigger picture, you see that 2008 was the height of the housing collapse and Great Recession. Investors feared a complete economic collapse, so the demand and price of gold turned up.

Gold Price Correlation to the Dollar

Gold is a hedge against the US dollar. When the dollar weakens, gold prices usually rise and vice versa. This is because gold prices are in US dollars, and a weaker dollar makes gold cheaper for foreign buyers.

The problem is that gold and the US dollar don’t have a perfect inverse relationship. There are times when both asset prices will fall, as they did in 2020.

Gold can also rise while the dollar strengthens, which happened in 2019 because even though the dollar was strengthening, investors feared a possible economic downturn and bought gold as a safe-haven asset.

Gold Price Correlation to the Stock Market

The stock market and gold prices have a negative correlation. This means when the stock market is up, gold prices usually fall, as they should. When the stock market is doing well, the demand shifts to the market.

There are times when the two move in tandem, like in the early 2000s. This again goes back to the earlier point of needing to look at the entire economic picture and not just one or two variables.

What Are Some Difficulties Buying Gold?

If you want to purchase gold as a store of value, know that it isn’t a simple process. There are many issues you have to overcome.

For starters, since gold is a physical asset, you need a place to store the gold you buy. You can’t just keep it anywhere, either. If someone knows you have $10,000 of gold in your basement, or tens of thousands, there are real security risks to consider. And real security costs money, so there is a real world cost to storing gold, not to mention it’s actual physical weight.

A standard gold bar weighs over 27 pounds. You could buy smaller bricks that only weigh 2 pounds, but as you accumulate the precious metal, the weight adds up.

Another issue is authenticity. If you choose to buy gold coins, you must ensure you buy real gold coins. While verification is easy, it does take time, and presents risk.

Finally, you have to deal with inconsistent pricing. Not all gold dealers will buy or sell gold at the stated rate. There will also be fees involved in the sale, increasing the price you pay when you purchase or lowering the price you get when you sell.

A better option for most investors is to simply invest in gold-related stocks and exchange-traded funds. This gives you exposure to gold without having to own it physically. However, this, too, is not without drawbacks. The biggest is that you don’t have a claim to the underlying gold the fund owns, which some investors say defeats the purpose of owning gold.

Is the Cryptocurrency Market Reducing Demand for Gold?

It is hard to say whether the rise of cryptocurrency is reducing the demand for gold because there is not a long history to compare. One recent study noted that there had been significant outflows from gold into cryptocurrency and suggested that crypto is a better store of value than gold.

But with the volatility of cryptocurrency and its lack of trading history during various economic conditions, it is hard to come to the same conclusion. There are too many variables that you need to take into account that have not happened since crypto has gone mainstream.

Many cryptocurrency proponents say this asset is a store of value like gold. However, looking at a chart comparing the two, one can easily see this is not the case. The value of gold is much less volatile, making it more of a store of value, while Bitcoin acts more like a technology stock. Some might flock to cryptocurrency as a safe-haven asset in difficult times, but the stability with historical prices of gold show it to be more safe with less volatile price fluctuations.

How Can Investors Buy Gold Without Owning Gold

If you would like to participate specifically in the gold sector without having to own and hold physical gold, you could buy these exchange traded funds that focus on gold. These are gold miners and suppliers that are publicly traded and the ETFs have a positive correlation with the price of gold. Here are the top gold ETFs to review.

  • SPDR Gold Shares (GLD)
  • SPDR Gold MiniShares (GLDM)
  • iShares Gold Trust (IAU)
  • Aberdeen Physical Gold Shares ETF (SGOL)
  • GraniteShares Gold Trust (BAR)
  • ProShares Ultra Gold (UGL)
  • WisdomTree Efficient Gold Plus Equity Strategy Fund (GDE)

Bottom Line

Gold is an excellent option for investors looking to hedge potential losses in the stock market. Since the price of gold tends to rise during economic uncertainty, it can help protect your wealth. Just consider the broader economic landscape, not just one or two economic indicators.

From there, make sure you use gold as a store of value and not as an asset to drive returns. It is there to help you take some risk off the table, just like some investors invest in bonds to mitigate the risk of investing in the stock market.

Take the time to review your portfolio and ensure that when downturns happen, you have a small percentage of your investments in gold to help offset your losses, a primary feature of investing with Q.ai.

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