Investing in Gold to Offset Market Risk? Think Again

After a 5-month period of strong equity growth, we are finally seeing a correction that corresponds to the current global uncertainty. China, which is the world’s second-largest importer, faces deflation concerns whilst Europe continues to suffer from war and high inflation. Comparatively, the US economy is standing tall, but many of its globalised companies are suffering.

The S&P 500’s growth has also been overly reliant on just a couple of companies. Without Amazon, Meta, Microsoft, Nvidia and Tesla, the S&P 500 has hardly grown at all in 2023. This overreliance on tech companies, which collapsed in 2022, has driven some people away from equities.

In times like this, gold is often called on as the answer to uncertainty. But, with the US dollar strengthening and a history of lacklustre growth, can we do better? Should I buy gold this year? The answer lies in the opportunity cost…

Gold performance against the stock market

FT from Million Dollar Journey, Canada's first-ever personal finance blog, says that "Gold has not been a good investment in the past. This goes against the sort of common sense wisdom that many people have passed along over the years. The numbers just don’t lie though.”

FT goes on to say, “Stock market historian Jeremey Siegel’s research has proven that a dollar invested in gold back in 1802 would be worth about $100 today. Wow – a 10,000% return you might think – that’s pretty spectacular. Here’s the thing though – that same dollar invested in the US stock market would have grown to roughly $35 Million Dollars today!"

Investing in gold 2023 will have seen modest growth far below the S&P 500. But, the issue isn’t just that returns are lower with gold, but there remains to be risk too. Often, people underestimate just how volatile gold can be, believing that tangible commodities do not suddenly start being less valued. In 2015, gold saw -11.59% growth, whilst in 2013 it saw almost -28% growth. These are the declines typically associated with a stock market crash in a particularly bad year.

Gold as a hedge

Historically, investing in commodities like gold have performed well during times of uncertainty. It makes sense that when the stock market is becoming very overpriced with high PE ratios and volatility, people seek out tangible, reliable assets.

So, whilst there may not be high growth potential, many consider it a reliable hedge. Yet, during the month of August, both the S&P 500 and gold fell in tandem for the first 3 weeks, with only a modest uptick for gold towards the end of the month.

Since 2005, gold has had a 0.14 correlation with the S&P 500, meaning that it’s fairly uncorrelated, but it’s actually positive rather than negative. This makes sense, because the stock market spends more years growing than it does falling, and so it would be unusual if gold did the exact opposite - spending more years falling than growing.

As for today’s context, investors seem to be seeking out the US dollar for hedging purposes, which has a 5.50% Fed reserve rate and only ~3% inflation compared to the EU’s 5.3%.

Alternatives to gold

One of the biggest reasons behind gold’s poor recent performances is the strength of the US dollar, and this highlights why there are many alternatives to gold right now. Whilst gold negatively correlates to the US dollar, and is thus seen as a hedge, it’s strong in part because the Fed reserve rate is at its highest level since 2001.

This high interest rate makes it appealing to uncertain, pessimistic investors to save money into savings accounts or high interest bonds. Both are closely linked to the fed rate, meaning savers can quite easily attain 5% APY right now without issue. Is the extra potential return from stocks at an added risk really worth the premium? Either way, gold is offering very little between the three.

US treasuries are another minimal-risk investment that are yielding well over 5% right now. It’s almost a surprise to have equities perform as well as they have in 2023 considering this environment, let alone a US economy stampeding at a 5.9% growth rate during contractionary monetary policy; successful policy, in fact, that has cooled inflation whilst retaining growth.

It was also the invasion of Ukraine that sparked turbulence in the commodity market. Many commodity futures skyrocketed due to their increased scarcity, such as wheat, nickel, and coal. Gold did increase during this time, but to nowhere near the same degree. This sparked a surge towards alternatives, and whilst these futures did see major pullbacks, investors aren’t exactly racing back into gold reserves.

Why gold lost its allure

The current environment is not exactly set up for a bull market for gold. Interest rates are high, the dollar is strong, and equities have been doing well prior to the month of August. But, the argument here is that we may never see gold as the go-to commodity it has always been.

With the rise of digital assets, the younger generation doesn’t have the same belief surrounding the value of tangible assets. In fact, even equity investors are increasingly just ETF investors, option traders, or spread betters who do not feel the same connection of ownership with their stocks as in the past.

Whilst NFT art is hardly going to be a standalone alternative to gold, it’s the changing perceptions of the newer generation of investors that may change the allure of gold forever. There are also increasingly creative ways to diversify and hedge a portfolio, meaning that investing in gold in 2024 is less on the agenda.

It has never been easier to invest in contemporary art, whisky, space, P2P lending, or ESG. So has gold, in fairness, through funds like GLD ETF, but it is quickly becoming one of many options for diversification.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes.