Gold reached a new high this week, crossing above $2,200 for the first time. Year-to-date, gold is up 8%, and since the end of 2021 it’s gained more than 20%, topping the S&P 500. This raises two questions: Can we expect this rally to continue? And does gold deserve a place in your portfolio?
To answer these questions, let’s start by looking at the drivers of the recent rally. The first factor is interest rates. While rates are still elevated, and the Federal Reserve has yet to cut its benchmark rate, it has indicated its intention to do so soon. As a result, other rates have already started to drop. The yield on the 10-year U.S. Treasury bond, for example, has edged down from almost 5% in October to 4.2% today. How do interest rates impact the price of gold? To understand the connection, think about it from the point of view of an investor with cash to invest.
Investments are, in a sense, all in competition with each other for investors’ dollars. Because gold doesn’t produce any income, it becomes relatively less attractive when investors can earn more elsewhere. When a simple U.S. government bond offers nearly 5%, gold looks much less appealing. But when interest rates start to come down, the scales begin to tilt back, and that’s what we’ve been seeing recently.
Another factor is geopolitical instability. There’s Russia’s ongoing attack on Ukraine, and terrorists seem to be striking with increasing frequency around the world, with attacks recently in Israel, Russia, Turkey, South Korea and Pakistan. Terrorists have also been attacking cargo ships off the coast of Yemen, disrupting a key global shipping lane. Uncertainty like this makes gold relatively more attractive because it offers a safe haven that’s independent of any country or currency.
There are other reasons, too, for gold’s runup. According to a Wall Street Journal analysis, China’s central bank bought more gold last year than it had in any year since the 1970s. Consumer demand for gold in China has also been strong, with jewelry sales up nearly 25% during the recent lunar new year holiday season. Overall, China increased its gold imports by 51% last year. Why the sudden surge in popularity?
One reason is the weakness in China’s stock market, which dropped in 2021, 2022 and 2023 and is down again so far this year. China’s real estate market has also been going through a rough patch. With these investment options looking less attractive, gold has become relatively more attractive.
Putting these factors together, it looks like gold prices have a lot of support. But in guessing where it might go from here, investors face two challenges. First is the fact that gold doesn’t pay any income. As Warren Buffett likes to say, gold “just sits there.” Gold actually costs money to hold, because it requires storage space and security. This is relevant because the cash flow that an investment generates provides investors with a tangible basis for valuing that investment—a concept known as intrinsic value. When an investment doesn’t generate any income, it’s very difficult to say what the right price should be, and that makes it much more unpredictable.
To be fair, gold isn’t the only investment lacking intrinsic value. Cryptocurrencies such as bitcoin also lack intrinsic value. But the comparison with cryptocurrency highlights three unique aspects of gold. First is its long history. Archeologists have found evidence of gold being used in jewelry in Mesopotamia as much as 4,000 years ago. So gold is hardly a passing fad.
Second, gold is an internationally-recognized store of value for governments. Indeed, for decades after World War II, under the Bretton Woods system, world currencies were pegged to the U.S. dollar, which, in turn, was pegged to gold at a fixed exchange rate. Though we’ve moved away from that system, central banks continue to hold vast reserves of gold.
And finally, gold has a number of industrial uses—in medical devices, in electronics and in aviation.
For all these reasons, despite gold lacking intrinsic value, it is a unique investment, and many feel it deserves a place in any diversified portfolio. For gold enthusiasts, the dynamics we’ve seen this year prove its value.
There is, however, another challenge gold bulls need to consider: You may notice that I’ve left out of the discussion so far any mention of inflation. Because, as noted earlier, gold is a store of value that is independent of any country or currency, many view it as an effective hedge against inflation. During the 1970s, for example, when inflation in the U.S. topped 12%, gold soared.
But we’ve seen gold do precisely the opposite over the past few years. In 2022, when inflation began to rise, gold fell. And in 2023, when inflation began to recede, gold began to rise. In other words, gold has run completely counter to expectations.
The bottom line: For investors, life would be easier if investments were more predictable—if we knew with certainty which factors would drive their prices up or down. For investments that carry intrinsic value, this dynamic does exist to some degree. Look at a chart of the S&P 500 Index, for example, and compare it to a chart of the earnings of the 500 companies in the index, and you’ll see they generally move in the same direction. Prices follow profits. But even so, the relationship is loose. That’s because there’s always more than one variable at work. Market sentiment, geopolitical news and other factors also drive stock prices. And they can drive prices in the opposite direction from earnings. As a result, despite having intrinsic value, stock prices can still do anything in the short term.
When it comes to gold—where there is no intrinsic value—the investor’s job becomes that much harder. As we’ve seen, some factors are positive for gold while others are negative. But because there’s always a mix of factors at work at any given time, it’s impossible to know which will ultimately win out. It’s for that reason, despite its recent gains, that I continue to recommend against owning gold—except as jewelry.
