“Nobody really understands gold prices, and I don’t pretend to understand them either.” Former Fed Chair Ben Bernanke
While stock prices have been setting new records this year, gold may yet turn out to be 2017’s biggest winner.
In August, gold prices surged 4% and the yellow metal was on track to outperform stocks for the first time since 2011, according to The Wall Street Journal.
But gold can be fickle. Its price fell as the month ended and some predicted it would continue to decline. Yet an anemic jobs report as September began led to gold’s highest price in a year – $1,329.56 a troy ounce.
Meanwhile, Jim Rickards, author of Currency Wars, predicted that gold will eventually reach $10,000 an ounce (although he didn’t say when).
This volatility is nothing new. As we noted in 2013, “Gold was selling for as little as $256 an ounce in 2002 and soared to nearly $2,000 an ounce in 2011. An investment of $1,000 in 2002 would have been worth about $7,800 in 2011. In May 2013, though, gold was back down to $1,343 an ounce.”
Time to Invest in Gold?
When an investment is volatile, you can make a great deal of money from it even in a short period of time. But you can also lose a great deal of money from it during a short period.
Even with the recent rally, gold is selling for less than it was in 2013. Which could mean there is plenty of upside potential. Or it could mean that gold was severely overpriced in 2011 and its price isn’t going anywhere.
So is the timing right to invest in gold? And how much of your holdings should you allocate to gold or other precious metals?
The key, of course, is understanding what affects the price of gold. And, as former Fed Chair Ben Bernanke said, no one really understands gold prices.
For example, when interest rates dropped after the financial crisis, gold prices rose. Gold doesn’t earn interest, so it’s logical for gold prices to fall when interest rates rise, as interest-bearing assets become more desirable. But there have been times when gold prices hit record highs while interest rates were rising. As recently as March, gold prices rose along with interest rates.
“We have consistently seen double-digit percentage increases in gold prices post a rate hike perversely,” Ross Norman, chief executive officer at Sharps Pixley, told MarketWatch.
Gold is sometimes used as a hedge against inflation, as its price may drop when inflation increases, but it is also sometimes used as a hedge against deflation.
The logic is that higher inflation will mean higher interest rates, but, according to Rickard, “The Fed wants to keep inflation under control, but what the organization really wants is negative real rates. That’s where inflation is higher than nominal rates. It does the Fed no good to raise rates unless inflation is going up even faster. Yet that’s exactly when gold does its job of preserving wealth.”
Gold prices also typically rise when the economy is performing poorly and fall when the economy is growing rapidly. The stock market, conversely, usually follows the performance of the economy.
In recent years, though, stocks soared even as the economy grew at a below-average pace, while gold prices dropped. Note, though, that many believe market performance was largely due to manipulation by the Federal Reserve Board. Initially, Fed actions sent gold prices soaring along with prices of stocks and bonds.
Fed actions weakened the dollar and when the dollar weakens, gold becomes a more attractive alternative, so demand causes its price to increase.
When the U.S. Labor Department announced that the economy added only 156,000 jobs in August, instead of the expected 179,000 jobs, and the unemployment rate ticked up from 4.3% to 4.4%, the dollar weakened and the price of gold increased.
World events also have an impact. Gold prices recently responded to North Korea’s saber rattling, with threats of using nuclear missiles on Japan or Guam, prices increased, but fell when the crisis seemed to be under control. In fact, it’s Rikards’ belief that a war is coming that led him to predict that gold prices would reach $10,000 an ounce.
Hedging With Gold
You could logically conclude based on the above that gold prices are going up – just as you could logically conclude that they’re not.
Given uncertainty and price volatility, it would be dangerous to make gold the focus of your investment portfolio. However, it’s a good bet to include it in your portfolio for diversification and as a hedge.
As gold prices typically move in the opposite direction as stock prices, it can protect the value of your portfolio if stock prices fall. And given that stocks are historically overvalued today, some allocation to gold would be helpful.
As Chad Morganlander, portfolio manager at Washington Crossing Advisors, told CNBC, gold acts as a “good insurance policy in a world of low returns, low volatility and high risk. … We have a long-term forecast of 4% return on gold. Still own it in our portfolio with a 5% position.”
Gold has also proven to be a good long-term investment. In 2000, it closed the year selling at $272.65 an ounce. Even at today’s price, it’s increased in value nearly 500% since then.