Gold punches above $2,700. Too far, too fast?
Weighing up the pros and cons for gold. Buy, hold or sell?
In this update:
My own first, naive step into gold investment, and other, better ways
Some gold market history, and the pondering long bull market
General reasons to hold gold
Current factors likely to drive gold higher, or pull it lower
How to react after such a strong price run
The first time that I invested in gold was back in 2003 or 2004. This was after I'd been posted to Hong Kong, to work on the regional strategy for my employer at the time (UBS Group, the global wealth manager and investment bank).
If memory serves, I'd read a couple of papers about gold's long-term role as a value preserver, and also about how government debts - which are nothing more than the aggregate amount of past fiscal deficits - were having progressively less incremental impact on propping up GDP growth.
It seems bizarre now, given all that's gone on over the past two decades, and the explosion of government debts since the 2007-2009 Global Financial Crisis. But I was already starting to get concerned about unsustainable government finances. Gold seemed like a good hedge, so I decided to dip my first toe into the gold market.
My first investment, as a naive gold newbie, was a gold-linked bank deposit via my local bank account in Hong Kong. Mainly because it was very easy to do.
As I researched gold investment further, I soon realised that this was one of the least safe ways to get investment exposure to gold. That's because it relies on the solvency of the bank. Any gold reserves that the bank might own are "unallocated", meaning not the property of the gold-linked deposit customers, such as myself.
Once I had worked this out, I looked for a safer way to own gold than gold-linked bank deposits. The Global Financial Crisis that started in 2007, when vast numbers of supposedly-safe banks went under and had to be rescued (or were allowed to fail - see Iceland), later rammed home why this is essential.
The choices for gold investment were thinner on the ground back then, involving such things as Perth Mint Certificates from Australia, or actively-managed gold mining funds with high fees. The very first gold exchange-traded fund (ETF) was launched in Australia in 2003, and the first US gold-backed ETF was launched in 2004, the SPDR Gold Shares ETF (NYSE:GLD). Gold ETFs made investing in gold as easy as buying any other share via a brokerage account.
By 2005, a London-based online bullion service called BullionVault had started up, and I think I was a fairly early customer (either late 2005 or early 2006, if memory serves). BullionVault offered a cheap and safe way to invest in large gold bullion bars (or part bars), stored in a choice of secure vaults in various cities (at the time in Zurich, London or New York).
You could (and can) buy and sell via a trading page on the website, making it very easy and convenient. At some point along the way (2010? 2011?) I met BullionVault's founder and CEO, and this only improved my impression of the service.
BullionVault was a pioneer. That's because before it existed private investors had to buy whole bars and pay a lot for storage and insurance, leaving bullion investing restricted to only the wealthiest.
There were copycat services launched later, especially in the US. But, unless something has changed radically in recent years, those were far more expensive than BullionVault in practically every scenario. That was due to significantly worse pricing when buying and selling metal, and/or much higher trading commissions, and/or higher custody fees to store the gold.
Of course, before such services (or the ETFs) there were always gold bullion coins, such as South African Krugerrands, American Eagles, British Sovereigns, etc. In my opinion, these should only ever be bought and collected in-person from reputable coin dealers with long histories. They should never be bought remotely from newer firms that send merchandise by post, unless you like the high risk of being scammed.
But bullion coins were (and are) only suitable for very long-term holdings. This is because the spreads between purchase and sales prices are so wide, to cover dealers' costs and leave them a profit. Also, coins are no good for very large investments, given the practical challenges of storing big coin caches in a safe way. Allocated bullion, insured and stored in a secure vault, is the best way to own a lot of gold.
Anyway, back to my first steps into gold in the early 2000s. I remember talking with a very senior investment bank colleague about gold, and him dismissing it since it earned no income yield (paid no interest coupon or dividend). This was a very common attitude at the time, and still is today for that matter.
Scepticism towards gold was rife at the time. This was perhaps no surprise, since gold was in a grinding bear market after a speculative market episode in 1980, followed by a big, long, drawn-out flop all the way until 2001.
Famously, in 1999 the UK's Chancellor of the Exchequer (translation: finance minister), a fellow called Gordon Brown, pre-announced that the Bank of England would sell half of its gold reserves.
This caused the already-depressed gold price to plunge further, bottoming out at $252.80 per troy ounce on 20 July 1999. The dark, gallows humour of professional traders labelled this trouser-tightening market moment as "the Brown bottom".
Gold stayed depressed until 2001, as the Bank of England worked through its sales. Things finally started to turn around in 2002, and gold has largely been in a monumental bull market ever since, although with some setbacks along the way.
Incidentally, part of the driver was that China permitted its citizens to own gold again after 2004 (if memory serves), having banned it after the communist revolution in 1949. This is an important fact that is often overlooked. China's huge population combined with its extremely rapid economic growth over the past two decades - and the huge numbers of very rich people that resulted - were important drivers for the gold price.
The fact that I first invested in gold at around the same time as it was allowed again in mainland China was a complete coincidence. But, with hindsight, it has undoubtedly been my most successful play on China's economic ascent.
The long bull market
At the time of writing, the dollar gold price is $2,738 per troy ounce. That's up 10.8 times since 1999's Brown bottom, in the space of a little more than 25 years. It's equivalent to an average, compound rate of return of 9.9% a year.
According to official data, US consumer price inflation amounted to 89.7% over the same time period. That works out at a compound average of 2.6% a year. Put another way, gold investments made about 7.3% a year real (above-inflation) returns since July 1999, on average and in US dollar terms.
Of course, many people believe that official inflation figures are understated, including me. This is mainly due to statistical tricks known as "substitution" and "hedonic quality adjustments".
(Substitution involves putting cheaper products in the inflation basket when prices rise - e.g. more chicken, less beef. Hedonic quality adjustments involve artificially adjusting prices down due to supposed improvements in product quality. For example, the same car model may have gone up in price substantially over time. But if it contains more tech or safety features than before then the inflationary effect is reduced or removed, as the buyer is deemed to have got more for their money. Never mind that its main function - getting from A to B - has not improved, and that more basic models may no longer be available.)
My best guess is that actual price rises are about one percentage point a year higher than official inflation statistics, and perhaps a little more than that. Even under that assumption, gold has delivered a substantial real return over the past 25 years.
I've stayed invested in gold ever since my first toe dipping in the early 2000s, to a greater or lesser extent. Sometimes I've owned a bit more gold, sometimes a bit less. But it's always been there, and I've learnt a lot more about gold - and precious metals in general - along the way.
During the period of the Global Financial Crisis, I think that my allocation to bullion peaked at around 50% of my financial assets (made up of bank deposits and investments).
That's far higher than I would usually want, or recommend. But it was an extreme moment when gold's value as crisis insurance really became valuable, before we knew whether the banks would really be saved. More normally, and allocation of somewhere between 10% and 25% is reasonable.
Along the way, I've read a lot about gold, and thought a lot about its purpose as an investment. The main reasons I like owning it are the following four things:
The main use of gold is as jewellery. The main gold-buying nations are China and India, which have deep cultural affinities for gold. Both have huge populations that are becoming steadily wealthier over time. Wealthier people buy more gold jewellery, on average. Meanwhile the global stock of gold only grows very slowly, and it is harder and ever more expensive to mine new gold. The global population continues to grow too. This combination of growing demand (more people with more money) and relatively fixed gold supply provides a long-term tail wind for the gold price. Over the ultra-long term, gold has preserved its value in inflation-adjusted terms. But if these huge countries (and others) continue to grow, gold seems likely to outperform inflation, on average, in coming decades.
Gold is a hedge against financial crises and a safe haven during periods of uncertainty, and there is no shortage of potential crises. Most developed country governments are effectively bankrupt and continuing to run up even bigger debts, along with printing money in vast quantities (e.g. GFC, Covid). The result will eventually be sovereign crises, with collapsing currencies and/or bond markets. Gold provides a haven from such situations.
Even more severe crises are possible, of a geopolitical nature. The Russian invasion of Ukraine surprised most people, and the war still has potential to expand if bad decisions are made by one side or the other. (I recently read that North Korean special forces are now in Russia.) Israel's conflicts with Hamas and Hezbollah terrorists, and their sponsor country Iran, could expand (with implications for oil and gas markets). China still has its eyes on Taiwan, and recently carried out naval drills close to the island. Chinese President Xi Jinping is 71 years old, meaning he is running out of time to achieve reunification within his lifetime, something that would place him close to Chairman Mao Zedong in the pantheon of Chinese communist leaders. In such a scenario as Chinese invasion of Taiwan, there is potential for North Korea to launch a simultaneous attack on South Korea, in order to spread US / allied forces more thinly in the region.
Although my favourite asset class by far is stocks, I like to have at least some diversification into other areas. Aside from short-term cash balances, ready to invest when prices are attractive, the other main alternatives are bonds and gold. Since I don't like lending to bankrupt borrowers with mediocre leadership (or worse) - which means most developed countries and their governments - this makes gold the default main option for portfolio diversification.
Thus, I think there are plenty of good reasons to own gold, as an asset that's likely to appreciate over the long term, as a crisis hedge, and as a general portfolio diversifier.
But boy oh boy, it's gone up a lot recently. Not that I'm complaining. But such big moves always make me question whether I should keep holding something. Or, at least, whether I should be trimming the position and taking some profit.
I happened to buy some shares of a gold bullion ETF in February, because I wanted to increase my gold weighting relative to gold miners (which are more volatile, usually) and also my overall portfolio. My notes from the time say the decision was to add low volatility crisis insurance against sovereign risk, and also as a bet on the likelihood of falling interest rates later in the year.
The timing was complete luck, as the gold price started shooting higher very soon afterwards. It's now up 34% (in dollars) in the intervening eight months.
Be under no doubt, that's a huge move for gold. In an ordinary year, my base expectation would be a percentage rise or fall in single digits.
The dollar gold price is up:
32% year-to-date
38% over the past year
64% over the past two years
78% over the past five years (mostly since the end of 2022)
113% over the past 10 years (mostly since 2018)
Here's a chart of the dollar gold price over the past 30 years (left-hand vertical scale shows $/kg, right-hand vertical scale shows $/troy ounce):
Source: goldprice.org
And here's a longer-dated chart going all the way back to early 1973, which clearly shows the speculative price spike in 1980 and long, grinding bear market that followed.
Source: goldprice.org
(Note: remember that the US dollar was pegged to gold prior to 1971, meaning that gold prices before that aren't meaningful reference points relative to today, even adjusted for inflation. In fact, by 1971, the dollar was so overpriced in gold terms - meaning gold was underpriced - that the first few years that followed are also largely meaningless. Personally, I think that the pent-up inflation from prior decades was baked back into the gold price by around 1975 or 1976, so that should be the starting point for any useful, historical time series. In any case, half a century is plenty of data.)
Glance at either of those charts and you'd be forgiven for concluding that the gold price has gone stratospheric, and that gold is in a speculative bubble. But hold your horses.
First, over long time periods anything that grows at a reasonably steady rate will have a price graph that looks exponential. Second, we should adjust for inflation (even official inflation) to get a better handle on where things stand with in relation to the past.
To which end, below is a chart of the dollar gold price since early 1975, adjusted for inflation and using a logarithmic vertical scale for the price. The inflation adjustments mean that all prices are shown in terms of today's dollars. The log scale means that percentage increases or declines always look the same size to the naked eye, as you move up or down the vertical scale.
(Put another way, something that increases at a constant rate per year will have an exponentially curved chart when using a linear vertical scale, and a straight line rising from bottom left to top right when a log vertical scale is used.)
Gold since early 1975, inflation-adjusted US$ per troy ounce, log vertical scale
Source: Macrotrends
Looked at this way, it becomes clear that the main bull market was between 2001 and 2011. Then there was a gold bear market from 2011 to 2018. Things took off during 2019, accelerated during the Covid panic and money-printing splurge, retreated as interest rates were raised sharply, and then gold has taken off again sharply since late 2022.
The move since then still looks extremely steep, albeit less steep than the second half of the late-1970s boom, and comparable with the 2001 to 2011 bull market progression.
Also interesting, using official inflation statistics at least, is that gold is now back around the inflation-adjusted speculative price peak of 1980.
That said, if we assume actual inflation was 1% a year more than the official CPI, then the missing inflation (with compounding) would be 55% over 44 years. Put another way, the 1980 peak shown on the chart would be equivalent to $4,259 per troy ounce in today's money, compared with the actual price today of $2,738. That would imply that the current price is 36% below the speculative peak of 1980, in real terms.
However, that really was a speculative peak. And the recent price run has still been very steep. Which makes me wonder whether the gold bull market is about to peter out, or even reverse sharply, at least in the short term.
So this still begs the question: should I hold on to my gold?
And there's no easy answer. All we can do is list out potential reasons for gold's price to rise further, and potential reasons for it to fall.
Potential reasons for gold to keep rising
More and more people are concerned about the parlous state of government finances in most developed countries. Fiscal deficits will get even worse when the next recessions strike, due to lower tax receipts and higher welfare bills.
Whoever wins the US presidential election, it seem likely that huge fiscal deficits will persist. Most US government debt is short-dated, meaning it has to be refinanced frequently at prevailing market rates. This means the government's interest bill - which has been rocketing recently - is highly exposed to market sentiment and prevailing yields.
Geopolitical risks remain high and currently show no signs of dissipating (Ukraine, Middle East) and could get much worse (Middle East, Taiwan / Asia).
Interest rate cuts by central banks have been relatively modest so far, and much less significant than most people assumed earlier in the year. Since gold doesn't pay a cash income to investors, there is an opportunity cost of owning it relative to cash deposits, treasury bonds / bills and dividend stocks. Assuming that rates will decline further in coming months and during 2025, that is a positive factor for the direction of the gold price.
Although central banks have been buying gold recently, retail investor interest has been quite limited so far, including very weak interest in gold-backed ETFs (see the chart in this post from Charlie Morris's ByteTree - one of the very best places for gold commentary). At the top of speculative markets, retail interest is usually off the charts, as latecomers pile in (just before the new money runs out and the bubble bursts).
Media coverage of the gold boom has been relatively limited so far, although I have definitely noticed an uptick in volume in the past few weeks. Again, when bull markets are near the top, there is usually masses of media coverage. We don't seem to be quite there yet.
Gold miners and silver haven't outperformed gold yet, at least not significantly. Usually, these substantially outperform gold itself in the later stages of a precious metals bull market.
Gold-tracking ETF (GLD - dark blue) vs a gold mining ETF (GDX - light blue) vs Silver-tracking ETF (SLV - purple) - US$ prices, past two years
Source: Yahoo Finance
Potential reasons for gold to start falling
It's moved too far too fast and is due for a sharp setback, not least if enough people decide to take profits.
Interest rates don't fall as fast as many expect in coming months.
Retail investor interest simply isn't going to get as high as it might have in the past, due to other non-mainstream investments such as cryptocurrencies (even though they are completely different beasts to precious metals), or a new generations of younger investors that are naive about the risks that abound presently.
Jewellery demand is poor due to China's weak economy, or impending major recessions in the US and Europe, as the excess money printed during the pandemic runs dry relative to GDP (now that the inflation splurge means prices have caught up), and non-zero interest rates start to bite as more and more loans are re-financed at higher rates.
The hard truth is that it's not possible to guess where gold is going next.
This is always the case with any investment. But it's even harder when it comes to things like commodity prices, including gold. Not that this stops plenty of people from making valiant price predictions. Such predictions are pure guesswork, but they sometimes turn out to be right, due to sheer luck.
Given major uncertainties, what should investors do?
Gold has seen a very big, multi-year price move, but we're not yet in a speculative (and thus media) frenzy. On the other hand, it really is abnormal for gold to move this much in such a short time.
Personally, I've decided to keep hold of my gold and gold mining investments, and not trim them.
This isn't because I'm super confident that they will keep rising. Far from it. Instead it's because my other investments - mainly in stocks - have performed more or less in line with gold over the past couple of years (after a challenging 2022).
This means that, despite gold's strong run, I'm not overweight gold compared with where I want to be, and I don't really want a lower weight in the overall portfolio. But I'm aware that the gold positions are riskier than last year, and with more potential downside.
Gold might fall, but that will probably mean that general macro conditions turn out to be fairly benign, which would most likely be good for stocks.
But some investors in gold and gold mining stocks could be in very different positions. That's if they already had big gold allocations a couple of years ago and other investments haven't kept up (such as large allocations to cash, bills or bonds, but also many stocks).
This is what I would do in that situation. Don't try to guess whether gold will keep going up, or is about to go down sharply. Just look at what percentage of your portfolio is exposed to gold, and make sure it isn't uncomfortably high if the market turns against you.
Put another way, how would you feel if your gold investments fell between 20% and 50% over the next year or few?
Again, I'm not predicting that this will happen. But all investors need to be comfortable with possible adverse outcomes. And that kind of range of potential falls certainly feels within the realm of possibilities, after such a major bull run for gold over one, two and five years.
For investors that conclude that they now have too much exposure to gold, or gold-linked investments such as miners, the sensible thing to do would be to trim exposure.
Even if you are convinced that gold is heading much higher, it is never, ever a good idea to have too much money riding on one thing.
Please send comments or questions to the email shown below.
Until next time,
Rob Marstrand
email: ofwealth@substack.com
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