When the stock market gets jittery, as it has during 2018, investors’ thoughts often turn to gold. Gold is seen as a safe haven during geopolitical and financial instability. It is also considered a hedge against inflation, a hedge against a declining dollar, and a good source of portfolio diversification.
The benefit of owning gold was evident during the 2008 financial crisis. From July 2008 through mid-March 2009, the S&P 500 index dropped 47%, while the price of gold stayed stable. For the three-year period of July 2008 through July 2011, gold was up about 75%, significantly outperforming the 3% gain of the S&P 500.
Two major gold ETFs (exchange traded funds) are GLD, which is the SPDR gold shares ETF managed by State Street, and IAU, the iShares gold trust managed by BlackRock. These ETFs are large and liquid, making it very easy to buy and sell gold.
Over the last 7 years, gold has not been a very good investment. The spot price of gold peaked in August 2011 at $1813.50 per ounce. Since then, it’s been on a steady downward path, down about 31% by July 2018. The S&P500 index, in contrast, is up about 139% during that same time period.
What could make the underperformance of gold change? If the stock market went into a severe correction, then the price of gold would go up. Financial advisors often recommend a 5% weighting in gold to help protect your portfolio against market downside.
A challenge is that it is very difficult to determine the appropriate price for gold. It does not pay a dividend. It does not generate any cash flow. It does not have a traditional book value. Therefore, many of the metrics we routinely use to evaluate stocks just do not work for evaluating gold.
Demand for gold is driven primarily by its use in jewelry, especially in India and China. It is also purchased by central banks, added to investment portfolios to reduce risk, and used in electronics, medicine and engineering.
If you are concerned about downside risk in your portfolio, then a small allocation to gold can provide peace of mind. Absent major economic volatility, however, it is difficult to make a compelling case for a big allocation to gold.