Is Gold Back?

After 10 years of underperformance, gold is back near its all-time high achieved in 2011. Gold is a unique asset in the public investing world. In the past, it was tied to currency. Some investors still consider it a store of value and a place to put their money during times of uncertainty.

Like all markets, the price of an asset is based on the balance between supply and demand. If there is more demand than supply, the price goes up. And vice versa.

So, let’s think about what has happened over the past 4 months that could be drivers of gold’s recent price increase:

• There has been economic uncertainty due to a health crisis
• Mining Operations extracting gold from the earth ceased due to coronavirus
• Delivery of gold became challenging because of reduced shipping capacity and increased costs to ship
• A halt in refining facility production further decreased supply

An unusually massive decrease in supply along with a typical increase in demand from investors during times of uncertainty meant that this precious metal’s price has gone through the roof during the pandemic.

When I think about those four drivers of recent price action, my first conclusion is mean reversion. It is reasonable to think that all four of those factors will revert to a semblance of normalcy at some point in the future. Like all short-term market movements, no one knows when.

Some tout gold’s ability to weather inflation and be a driving force of diversification in portfolio management. It is true that gold is not correlated with equities. But it is not the best choice for diversification if you consider the following.

From 1976 – 2019 gold and US corporate bonds both returned 5% annualized and adjusted for inflation. Gold’s standard deviation was 2.5 times higher than bonds. If you have two assets that have the same return, you choose the option that is less volatile. That is not a knock against gold. That is prudent portfolio management.

You cannot deny the fact that gold has provided an attractive return recently. But global pandemics that shut the world down don’t happen on a regular basis. Even though some still consider it a store of value, gold is another commodity on a long list of natural resources that have proven to be a difficult investment to have sufficient returns for the assumed risk.

-Mark Hume-