In uncertain times, investors often look to gold as a safe haven. This is because gold is perceived as an "alternate" currency whose value does not depreciate along with your ordinary paper money. Even as our money suffer from decreasing value through inflation, investors believe that gold's value is preserved.
Adding to gold’s allure is the strong performance of the metals sector in 2016. While commodities as a whole have faced a bear market in recent years — the Bloomberg Commodity Index, which tracks 22 commodities, fell by 35% since the start of 2013 — metals have sometimes been a gleaming exception to that trend. The S&P Metals and Mining Industry (SPSIMM) clocked in as the best-performing sector in 2016, surging by 101.5%. While gold rose by a more modest 8.6% in 2016, the trend still raises the question: Should everyday investors add more of the precious metal to their portfolio?
Here are three reasons to consider doing so, along with some measured advice about how much gold-plating you should actually add to your portfolio in 2017.
1. Inflation & Exchange Rate Fluctuation
In recent months, the US Fed has promised further hikes to interest rates in 2017, which could serve to sustain rising inflation. As recently as January 18, the CPI had increased by 2.1%, marking the largest year-over-year increase since June 2014. For other countries, this means great uncertainty about their exchange rates, creating a nervousness among global investors about the value of their assets. What this generally means is that no matter what currency you are holding, the future of the value your money is uncertain. This fear could certainly increase gold's value, since it is viewed as a safe alternative to paper money. As the The Wall Street Journal noted, some investors tend to buy gold on signs of quickening inflation, believing the metal will hold its value better than other assets when consumer prices rise.” The affected assets include interest bearing investments like bonds, which drop in price as yields rise in step with interest rates.
2. Correlations Are High
A traditional hedge against uncertainty at home is to invest elsewhere in the world, where differing conditions should prevail. Yet as trade becomes increasingly globalized, there’s a rising correlation of performance among stocks around the world. Blackrock reported that between 1980 and 1989, the correlation between the movements in U.S. and international stocks was a modest 0.47 — meaning these investments tracked one another less than half the time. However, more recently this correlation has increased to 0.88, which approaches synchronicity.
Clearly, diversification isn’t what it used to be. This change poses a problem for investors who believe they are diversified because they own a mix of domestic and international stocks. Even balancing a portfolio with bonds does little to help. A traditional portfolio of 60% stocks and 40% bonds experienced an astonishingly high correlation of 0.99 to a stock-only portfolio for the entirety of the 1990s.
By contrast, as recently as the third quarter of 2016, the correlation between gold futures and the S&P 500 was 0.63. The long-term correlation is a tiny 0.06, according to 30 years of data from FactSet.
3. New Political Landscape Brings Uncertainty
In these early days of the Trump presidency, the administration’s long-term policies remain unclear. What is clear, however, is that this administration is likely going to destabilise the international political scene even more so than now. It’s true that the equities market continues to hit new highs on expectations of a friendlier business environment, but it’s unclear how long that growth will continue. High share prices mean investors will need to see remarkable returns from companies in the next several quarters, and some firms will surely fail to deliver because their high valuations are based less on fundamentals and more on aspirations.
Gold, however, is finite and, compared with stocks, its value may be influenced less by promises, whether kept or not, of decreased regulations, tax cuts and infrastructure building. The managing director of GoldSilver central illustrated this preference for gold amid a murky future. Brian Lan remarked: “Buying shows that people are looking ahead this week with Trump's inauguration and discussions on Brexit. There is a lot of uncertainty moving forward."
The bottom line: There are certainly good reasons to consider holding more gold in 2017. It is a good defensive asset in a troubling and uncertain time: market valuations are high in the US and various private/VC markets while the economic and political backdrops are unstable at best. However, the metal, like any other investment, is best considered as a small part of a larger picture. In the long run, gold has not been a winning investment; its inflation-adjusted annualized return between 1900 and 2011 is just 1.0%, compared to 5.4% for stocks. At most, consider a small holding of gold not to exceed 10%. If you anticipate making drawdowns from your portfolio in the near term, you may want to consider an even- smaller exposure.