Gold at an all-time high: should I jump on the gold rush hype train or stay at the side-lines? Upcoming US elections may be the pivot.
With gold recently reaching new all time-highs, the question posed by many professional investors is whether addition of gold to a well-diversified portfolio would be a smart strategic move at this point in time. The goal of this article is two-fold: in the first half, I’d like to go over the main utilities of gold as an investment in the context of a global portfolio and in the second half, I will reflect on where I anticipate the price of gold headed forward, dependent on how US elections unfold.
Part 1. Gold — old but bold. Why should I, as an investor, care about gold?
Gold, in the context of an investment portfolio, can serve as an alternative means of store of value and as such, serves multiple functions in a portfolio context:
(i) a safe haven asset (ii) a substitute for cash deposits (iii) a diversifier in an equity/bond portfolio. Let’s go through each of these use cases.
(i) Gold as a safe haven asset
Let’s kick-off with a simple hypothetical example. Suppose that Euro currency depreciates against both US Dollar and Japanese Yen, on the back of recession fear. Against the background of depreciating Euro, European investor wouldn’t be very well off investing her money in equities/bonds denominated in foreign currency. For example, Euros can’t buy as many shares of Nvidia, denominated in USD, or as many certificates of Japanese government bonds, denominated in JPY.
At the same alternative sources of value, such as gold, aren’t attached to any currency pair and therefore regain their prominence amongst investors in times of currency depreciation. In the context of a global portfolio, gold could therefore serve as a good substitute to your foreign currency investments depreciating in value.
A more complicated real-life example. Ever since 2014 when Russia invaded Ukraine for the first time, Russian Rouble had been depreciating in value relative to major currencies, becoming as worthless as 1 eurocent at some point. RCB (Russian Central Bank) anticipated continued depreciation of the currency and started to strategically accumulate gold reserves in 2014, more than doubling the reserves by the start of 2022, just before the war between Russia and Ukraine broke out. In the hindsight, the strategy turned out to be an extremely efficient way to keep the monetary system solvent, as gold transactions, very much like cryptocurrency transactions, cannot be traced back to the buyer or seller, making it a great source of liquidity for a sovereign country that may or must keep its anonymity.
(ii) Cash Deposits/3-month Treasury Bills
Once again, let’s start off with a simple example. Any person, like you or me, could go to a bank right now and open a cash deposit, that would steadily accumulate interest over time — a relatively safe way to store money. Yet, the cash deposit becomes less attractive when interest rates on deposit go down, as compensation for a risk of bank going bankrupt is no longer commensurate with the return that you get. In such a case, gold regains its prominence as a safer alternative — the so-called safe haven asset.
A more complex example. Imagine it is 2010 and Sarah, a novice investor, faces a decision: to invest $10,000 in gold or put the same amount into a cash deposit account. The global financial crisis of 2008 is still fresh in her memory, and the markets are volatile. Sarah wants to protect her wealth against uncertainty and inflation. Gold historically acts as a hedge against inflation. If inflation were to rise, the real value of your cash deposit could decrease, whereas gold’s value might increase. Moreover, shortly after financial crisis, there was a lack of confidence in financial institutions. The possibility of bank failures or financial instability made gold, a tangible asset, more appealing.
- Gold Investment: Sarah purchased gold at approximately $1,200 per ounce, acquiring about 8.33 ounces. By 2020, the price of gold had surged to over $1,800 per ounce, making her investment worth approximately $15,000, a 50% return over 10 years.
- Cash Deposit: If Sarah had chosen the cash deposit, she would have earned a modest interest rate of around 2% per annum. Over 10 years, her investment would have grown to about $12,190, assuming the interest was compounded annually.
Decision to invest in gold over a cash deposit paid off, especially in the context of protecting her wealth against inflation and currency risks. While cash deposits offer safety and liquidity, they may not provide the same level of wealth protection or growth potential as gold.
(iii) Gold as a diversifier in a classic 60/40 equities/bonds portfolio
Gold can also function as a diversifying asset class in a standard 60% equity/40% bond portfolio. As you can see below, addition of gold allocation, all else equal, would slightly reduce your total portfolio return and would have significantly reduced your portfolio drawdown during financial crisis of 2008 (in other words, your worst-case return) on a 1- and 5-year horizon.
Partially, this is due to low correlation of gold with other asset classes, such as equities and bonds — in other words, gold returns tend be high, when returns for equities and bonds are low (and vice versa). One of the reasons for risk-reducing property of gold is its positive skewness — gold returns tend to rise faster than they fall, which is contrary to stock markets that tend to have a negatively skewed distribution — in other words, stock market often returns a small positive return and a large negative loss. Another reason lies in the fact that ownership of gold doesn’t pay any cash income streams, unlike stocks that pay dividends and bonds that pay coupons.
Part 2. Will the Gold rush mania continue?
In this second part of the article, I will provide some commentary on where I see price of gold headed forward. In order to do so, I’d like to provide some colour on the macro and geopolitical events in the US, which are of importance to the interplay between supply and demand for gold.
USA: Fed to cut the interest rates, Trump vs. Harris
At this point in time, it is widely anticipated that the Federal Reserve will start cutting interest rates in September. In fact this is one of the reasons why the gold price has been rallying recently, as interest rate cutting makes gold more attractive compare to cash/cash-generating assets. Likely, the expectation that Fed will start normalizing interest rates has already been priced in by the markets.
Yet, the more important and widely-anticipated political event in the US this year are the upcoming presidential elections — would election outcome likely impact the direction in which gold price moves? The short answer is: “yes, very much so”. Let’s first look at the likelihood of either candidates winning according to the public. Currently, the national average of betting odds (which I believe to be a more objective representation of the market sentiment, than national polls) predicts a slightly higher chance of Trump taking the race. At the same time, to be fair, Kamala stepping in the place of old Joe, gives Democratic party an actual fighting chance!
If Donald Trump gets elected
Trump’s election is likely to be bullish for gold for several reasons. Namely, his unpredictable manner of handling geopolitics and pro-growth macro policies.
(1) Less certainty on geopolitics
Donald Trump was often considered the “wild card” when it came to geopolitical policy-making during his presential term. If Donald Trump gets re-elected, his second presidential term is likely to be no different. It is unclear how Trump will continue handling the trade tensions with China and whether he would like to intervene in the war between Russia and Ukraine. A higher degree of uncertainty associated with Trump’s geopolitical course of action would likely encourage investors flee towards safer-haven investments such as gold.
(2) Push for pro-growth policies
As a businessman in mind and heart, Trump’s economic course of action for the country was always clear: “growth, growth, more growth!”. With such a pro-growth policy plan, Trump will likely continue advocating for tax cuts and deregulation. While these policy measure could certainly spur economic growth, they may also lead to renewed inflationary pressures. As we already learned in the first half of this article, gold regains its prominence in times of increasing inflation, as it is a great inflation hedge. Likely, Trump’s pro-growth policies will also drive the gold prices higher.
All in all, Trump’s election might lead to higher gold prices due to increased geopolitical and market uncertainty, higher inflation expectations, and potential pressure on the dollar. Investors might flock to gold as a safe-haven asset and inflation hedge.
(3) Potential Dollar Weakness
The pressure on the Fed to maintain low interest rates, as a part of the pro-growth policy plans, will likely lead gold prices to rise. As we saw previously, gold is typically inversely related to the dollar, so a depreciating dollar makes gold cheaper for foreign investors, boosting demand.
If Kamala Harris gets elected:
Harris’s election is likely to be bearish or neutral for gold for several reasons. Her more predictable policies, balanced inflation approach and support for Fed’s independence.
(1) More Predictable Policies
Harris is likely to pursue more predictable and conventional economic policies, which could reduce market volatility compared to Trump. While this might lessen the safe-haven demand for gold, it could also create a more stable environment for long-term investors.
Harris’s focus on social equity and climate change might lead to significant investments in these areas, but these are less likely to generate the kind of market uncertainty that drives up gold prices.
(2) Inflation and Monetary Policy
Harris might support a balanced approach that focuses on both growth and inflation control. If her administration is seen as keeping inflation in check, this might reduce the demand for gold as an inflation hedge, potentially lowering prices.
Furthermore, Harris is less likely to pressure the Fed into aggressive monetary easing. A more balanced or tighter monetary policy could lead to a stronger dollar, which would generally put downward pressure on gold prices.
