The rise in gold prices thus far in 2024 is attracting the attention of new investors as it is already rivaling the best yearly returns the precious metal has seen in the last couple of decades.
Before jumping on the gold train, investors should consider some of the risks associated with owning the precious metal, which have the potential to derail their long-term growth strategies.
The first thing to consider is that the current gold boom is not typical of the metal’s price pattern over the last five decades. Since 1973, the year it started trading freely, gold has risen just 21% of the time. That’s compared to stocks, which have produced positive returns 74% of the time during that same period. So, while gold is having a good run right now, it’s likely to be short-lived.
So, what’s behind this steep rally in gold? As with most gold booms, it’s the usual suspects, including:
Economic uncertainty: Since the pandemic, the economy has been teetering on a slowdown with concerns of a recession, pushing investors toward safe-haven assets.
Weakening U.S. dollar: Gold typically has an inverse relationship with the dollar, which has come under pressure due to changing expectations around interest rates and concerns over U.S. fiscal policies.
Inflation concerns: Historically, persistent inflation has driven demand for gold as a hedge against rising prices.
Geopolitical tensions: The last few years have seen a rise in global tensions—i.e., Ukraine, China, the Middle East—leading to increased demand for gold as a store of value during times of uncertainty.
Interest rate expectations: Gold tends to perform well during periods of low interest rates. After several years of raising rates, gold investors may be anticipating rate cuts by the Federal Reserve.
These factors have converged to create an ideal environment for gold prices to soar. So, why would investors maybe not want to include gold as part of their long-term investment strategy?
Gold Risks And Drawbacks
Unquestionably, with its unique properties and performance during period of economic and geopolitical uncertainty, gold can be a useful asset for portfolio diversification. However, it is not without certain risks and drawbacks, making it a challenging investment for investors seeking long-term growth.
Lack Of Intrinsic Value
When you invest in a stock, you take partial ownership of a company that produces goods or services, generating revenue and profits. Bonds are backed by the promise of future interest payments. Gold has neither. Its value is primarily based on what people are willing to pay for it at any given time, making it highly vulnerable to changes in market sentiment.
Lack Of Yield
Unlike stocks, which can pay dividends, or bonds, which generate interest payments, gold doesn’t produce any cash flow. The only way to earn a return on gold is to hold it for capital appreciation.
Opportunity Cost
Holding gold and waiting for the price to appreciate over the long term can entail significant opportunity costs. Historically, stocks have outperformed gold by a wide margin. Since 1973, when gold started trading freely, the S&P 500 has generated an annual return of 11.1%, while gold has returned 6.0% through December 2023. If your long-term goal is to grow your assets, you lose significant ground by owning gold compared to other investments. That opportunity cost is more pronounced during periods of strong economic growth when stocks tend to perform well.
Higher Risk
More importantly, while gold has underperformed stocks over the long term, it is also riskier. Since 1973, the annualized standard deviation of the S&P 500 has been 15.5% and 19.0% for gold. That’s nearly 23% higher volatility for a third less of a return, which raises the critical question of why an investor would want to invest in gold with its higher volatility and smaller returns.
Higher Taxes
In the U.S., physical gold and gold ETFs are considered collectibles, which subjects them to a higher capital gains tax rate than stocks or bonds. Higher taxes can reduce the net returns from gold, making it less attractive on an after-tax basis.
Market Sentiment And Speculative Bubbles
Throughout history, gold has been prone to speculative bubbles, where prices rise rapidly due to increased demand driven by fear or market hysteria rather than fundamental factors. These bubbles have been known to burst as quickly as they expand, leading to severe losses. The gold price surge during the late 1970s and its subsequent collapse in the early 1980s is a prime example.
Inflation Hedge Argument Is Overstated
Gold is widely touted as a hedge against inflation, but its reliability in this role is not as clear-cut as many believe. While gold did shine in its performance versus the high inflation of the 1970’s, averaging a 35% annual return from 1973 to 1979, it has underperformed against both inflation and stocks since.
Other assets, such as stocks and real estate, may offer more reliable inflation protection while also providing income.
Stocks Are An Inflation Hedge
Stocks are not often mentioned as an effective hedge against inflation. However, their historical returns show that they typically perform much better than gold during periods of inflation, particularly the stocks of well-managed, high-quality companies with their ability to consistently compound earnings.
While most investors invest in stocks for their growth potential, their ability to outpace inflation is critical to their positive adjusted returns over time.
Why People Still Buy Gold
Despite the risks and drawbacks of gold, its historic role as a store of wealth and medium of exchange can be reassuring to investors during times of economic uncertainty and geopolitical instability. In addition, its scarcity and long-term appreciation potential appeal to investors seeking diversification. Though it’s subject to short-term fluctuations, it’s never likely to be worth zero, which may also appeal to those concerned about preserving their wealth.
In Conclusion
Still, gold is typically an unreliable and risky investment that does not match equities in returns or inflation protection. Its price depends on fear and speculation, not value or income. Investors should consider the trade-offs of owning gold before adding it to their portfolio.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Jonathan Dash,
Founder and President
Email:Â info@dashinvestments.com