Investing

Three Reasons to Consider Gold Now

In uncertain times, gold often becomes a popular investment because many investors see the precious metal as a safer haven than other options. Adding to gold’s allure is the strong performance of the metals sector in 2016.

Where commodities as a whole have faced a bear market in recent years — with the Bloomberg Commodity Index, which tracks 22 commodities, falling 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 Fears Persist

In recent months, the 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.) Looming inflation could further increase gold's value. 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. A New Presidency Brings Uncertainty

In these early days of the Trump presidency, the administration’s long-term policies remain unclear. 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. 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.

Justin Song

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.