For thousands of years, gold has been the symbol of wealth, power, and prestige. For centuries, gold has been regarded as almost the quintessence of an investment, and many people still believe that gold prices will rise when political and economic circumstances turn negative.
Gold and Inflation
Gold’s primary appeal as an investment is as a hedge against inflation. Because gold is a non-productive asset, its price tends to rise during inflationary periods.
Gold prices have historically risen in response to high real interest rates. For example, in the early 1980s, gold prices rose in response to high real interest rates. In 2012, gold prices climbed in response to an increase in real interest rates.
Gold and Monetary Policy
One of the primary reasons for investing in gold is the belief that it is a reliable store of value. If this is true, then prices of gold should, in theory, be able to move independent of the monetary policies of any government.
Gold prices are affected by monetary policies because they affect the value of the dollar. The dollar is the base currency for international trading, meaning that gold prices are expressed in dollars.
The U.S. dollar is the world’s reserve currency and is widely used as a medium of exchange, a unit of account, and a store of value.
Gold and Economy
Gold, as a store of value, has always been popular in times of economic uncertainty. It is generally accepted as a store of value and its price tends to rise during times of crisis or uncertainty.
The price of gold does rise in times of economic uncertainty, but gold cannot be the only investment you look at. Gold can be a good hedge against inflation, but it does not offer high returns.
Investing in gold and other precious metals is not recommended for investment purposes. A financial planner would advise you against investing in gold, as it is not liquid. Gold ETFs are a much better option.
Gold and Financial Markets
Gold prices tend to move lower when interest rates are rising and bonds are rallying. This is because rising interest rates tend to make bonds more attractive than gold, and rising bond yields tend to make gold less appealing.
Gold tends to be priced higher when the stock market is struggling. During stock market corrections, investors often seek refuge in precious metals.
Investors tend to buy gold when inflation is rising, and the yield on short-term bonds is relatively low. Inflation is the general rise in the prices of goods and services, caused by excess demand for goods and services. Higher inflation means rising prices for consumers, and this tends to make gold a desirable asset. Rising inflation also tends to lower the yield on short-term bonds, making them less attractive in comparison to gold.
Gold and Asset Allocation
Investing in gold is much like investing in any other asset class. Gold is a commodity which behaves differently from the rest of the asset classes. Gold has low correlation to stocks, bonds, commodities, and currencies, and has historically traded inversely to the U.S. dollar.
In 2017, gold was hit by rising inflation expectations, falling U.S. interest rates, and a strong dollar. The dollar strengthened as the Federal Reserve hiked rates, which pushed gold prices down. The gold price was 0.4% lower in 2017 compared to 2016 and down 5.4% from its highest in 2016.
The Bottom Line
Gold is not a good long-term investment. It has low liquidity, persistent price volatility, and is hard to value.
There is no set mathematical formula for determining if gold is a good buy, but investors can consider other factors such as inflation, interest rates, and the relative strength of other currencies.