Is all that glitters gold?

The last two years have been kind to investors. 2022 was a brutal readjustment to the end of the cheap money era that lasted from the financial crisis to Covid. But once prices had reset by October that year, the stage was set for a renewed bull market. The FTSE 100 has provided a total return of nearly 25 per cent, including reinvested dividends, and the S&P 500 around double that. Bonds, too, have stabilised in anticipation of a turn in the interest rate cycle; the Bloomberg Global Aggregate Index, also a combination of capital and income, has offered diversification and a 3 per cent return over the same period.

But one of the best performing assets over the past two years has been neither an equity index nor fixed income. It has certainly not been oil, which has fallen by nearly 20 per cent since 2022 as demand from China has plunged and investors have anticipated a slowdown in America. Rather, it has been what John Maynard Keynes famously described as ‘a barbarous relic’. Even without the benefit of an income stream (the main driver of total returns from most investments), gold has given investors a 54 per cent profit since September 2022.

Gold is a volatile asset and can require extreme patience at times. If you had bought an ounce of the precious metal in September 2011 at the height of Europe’s sovereign debt crisis, you would have paid around US$1800. You would have had to wait until mid-2020, when there was still no end in sight to the Covid pandemic, before that investment was, briefly, back above water. Two years ago, you would still have been in negative territory. Gold does nothing for years, and then suddenly it takes off.

If you are prepared to hold for the long term, gold can be a great store of value. But you might need to torture the data to get the answer you need. If you had invested in gold during the final months of the dot.com bubble 25 years ago (not long after Gordon Brown famously sold the UK’s reserves at the bottom of the market), you would have made ten times your money. That’s one and a half times better than the total return from US shares and three times better than what the FTSE 100 has delivered on the same basis. If you had bought 30 years ago, however, gold would have trailed the equity markets on both sides of the Atlantic.

That is the context in which investors should view the current enthusiasm for gold. There is a long list of reasons why gold is rising at the moment, and it may continue to do so, but surges in the gold price are usually followed by long periods of drift.

So why have investors been so keen on gold?

First, the obvious - supply and demand. There are some big buyers out there, most obviously central banks looking to diversify their reserves away from the US dollar at a time of economic fragmentation and rising geo-political tensions. Goldman Sachs estimates that reported and unreported central bank purchases have been running at nearly three times the post-2010 average in the last two years. Other sources of higher demand include new industrial uses in electronics and renewable energy. It’s no longer just about investment and jewellery.

As with other commodities, like copper, cranking up supply to meet that higher demand is a slow burn. Mining output has been stable in recent years and with limited new supply hitting the market, the path of least resistance for the gold price is up.

The second tailwind for gold is the interplay between inflation and interest rates. The precious metal finds itself in a sweet spot today between modestly falling but still sticky inflation and easing monetary policy. Gold is viewed as a hedge against inflation and, while price rises are moderating, core inflation remains persistently above central banks’ targets. At the same time, falling interest rates reduce the opportunity cost of holding an asset that pays no income. With interest rates at 5 per cent, you are giving up quite a lot to hold gold in your portfolio. Less so at 3 per cent.

The third reason gold is rising in value is that, for right or wrong, people trust it. President Herbert Hoover said, ‘we have gold because we cannot trust government’. John Pierpoint Morgan’s riff on the same theme was ‘gold is money. Everything else is credit.’ Gold has no counterparty risk. The value of shares is tied to the performance of a company; bonds are only as good as the business or government that issues them. Gold is a bitcoin you can put in your pocket. It’s accepted globally, and it’s liquid. You will always find a buyer for your gold when you need one.

The final reason gold is going up is that it is going up. For years on end no-one mentions the precious metal in polite company. Then articles making the case for gold hunt in packs. The problem with buying an asset like gold when momentum is on your side is that when the pendulum swings back the other way there is little of substance to support the price. A share or bond will find a floor when its yield moves too far away from the return available on comparable investments like cash or property. But there’s nothing to say that gold is under-priced at US$1,000 an ounce or over-priced at US$3,000. The price is just what it is.

So, I’m a sceptical bull. I do have some exposure to gold myself, and I’m glad I have over the past couple of years. But if someone were to ask me today whether they should too, I would struggle to answer them.

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Please note that the views expressed in this article are my own.