Gold is a commodity investment that gets mixed reviews in the circles of financial experts. It also has a lot of sentiment attached to it. Some sing the precious metal’s praises, while others warn against adding it to your portfolio.
So, why does gold elicit such polarized responses?
Well, when we look to any of our investments, we must remember the purpose of investing in the first place. We invest our funds in different ways in hopes of earning of positive return on our principal.
However, as we all well know, no one can predict with 100% certainty what any investment will do. What we can do, though, is look to historical trends and financial data to draw correlations that may provide some helpful insight.
When is gold worth it?
So, when we look at gold and try to determine if it is a worthwhile investment in a certain climate, we must first understand its strong correlation with real yields. Gold tends to have an inverse correlation to the 10-year treasury yield[i]. In other words, when the 10-year treasury yields drop, gold tends to rise.
There are a number of factors that contribute to the phenomenon including broad money supply growth[ii] and consumer sentiment, but the fundamental determinant seems to be opportunity cost[iii].
Due to its scarcity, gold tends to be a natural hedge against inflation[iv]. But at the same time, the commodity pays no yield and carries a small storage cost, which means it can tend to be a slightly negative-returning asset. It can be an attractive asset when other interest-bearing assets fail to outpace inflation, but less attractive when those interest-bearing assets do outpace inflation.
Consider this example: If inflation is 1.5% and treasuries pay 3.5%, then the actual or real yield is 2%. In this climate, we believe that gold’s opportunity cost may not make it worthwhile. However, if inflation is 1.0% but treasuries are only yielding 0.5%, then their real yield is -0.5%. In this situation we feel holding treasuries would cost you and gold may be the more appealing option.
Recent Movement in the Gold Market
We have been able to observe this correlation over the past five years in the gold market. Starting in mid-2018[v] when GDP growth peaked and inflation and treasury yields began to decline, gold enjoyed an almost 2-year long bull run. This past August, 10-year yields began rising and gold was bought in a frenzy. [vi]Shortly after, unsurprisingly, the market shifted into correction as treasury yields continued to become less negative. [vii]
Since the beginning of November, things have shifted once again. Real yields hit a local peak only to move back down again. Naturally, we saw a sharp sell off in gold at this time.[viii] If real yields did indeed reach their local top last month and rates continue to decrease, this could be a compelling time to consider adding gold to your portfolio.
Still unsure if adding gold to your portfolio is the right move at this time? Speak with your trusted financial advisor, or contact our URS Advisory office to schedule a complimentary initial conversation today to discuss your options.
[i] https://www.fxstreet.com/analysis/gold-has-an-inverse-relationship-with-the-us-dollar-video-202012021112 2 December 2020
[ii] https://www.investopedia.com/terms/b/broad-money.asp 2 December 2020
[iii] https://seekingalpha.com/article/4225399-why-you-should-wait-to-buy-gold-opportunity-cost-of-holding-metal-is-still-rising-for-now 2 December 2020
[iv] https://www.investopedia.com/terms/i/inflation-hedge.asp 2 December 2020
[v] https://www.fnarena.com/index.php/2020/04/27/a-massive-bull-market-is-building-for-gold/ 2 December 2020
[vi] https://www.nasdaq.com/articles/yields-jump-gold-falls-ahead-of-record-10-year-treasury-supply-2020-08-12 11 December 2020
[vii] https://www.lynalden.com/gold-stocks/ 2 December 2020
[viii]https://www.dailyfx.com/forex/fundamental/us_dollar_index/daily_dollar/2020/11/25/Gold-Price-Forecast-November-Selloff-Warns-of-Shift-in-Market-Behavior.html 11 December 2020
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