Gold has been used as a storehouse of value for thousands of years and while it isn't used in day-to-day transactions anymore, it can still play an important role in your portfolio. Here are five reasons why investors ought to consider including at least some gold in their investment account.
No. 1: Diversification
Perhaps, diversification is the single best reason why gold deserves a spot in your portfolio. Historically, gold is weakly correlated to the performance of the stock market, which means its value may fall when stocks rise or rise when stocks fall.
In simple terms, correlation is the relationship between two or more investment types. If two or more investment types have a correlation of 1.00, they'll move in perfect unison up or down and if they have a correlation of -1.00, the two investments will move in opposite directions.
For example, the SPDR Gold Trust (NYSEMKT:GLD) is the largest gold ETF and since 2004, its correlation to the SPDR S&P 500 ETF (NYSEMKT:SPY) is only 0.33. That relatively weak relationship to the S&P 500 index helped SPDR Gold Trust ETF investors in the past by protecting at least some of their account value. When the S&P 500 lost 36.7% of its value in 2008, the SPDR Gold Trust ETF actually gained about 5%.
The past doesn't guarantee the future, but gold's outperformance during the Great Recession helps demonstrate why owning some gold in stock portfolios may make sense.
No. 2: An inflation and dollar hedge
Inflation is a general increase in price that reduces the purchasing value of money. We haven't had to worry too much about inflation lately, but global economic growth is picking up and as a result, rising demand for goods and services could begin to rise faster than the supply, causing inflation to increase.
If inflation increases, then it could be good news for gold investors. While more gold can be mined out of the ground, there's ultimately a limited supply of it on earth. That's unlike money supply, which can be increased simply by adding more printing presses.
The potential for rising gold prices to protect investors during periods of inflation is reinforced by the fact that the SPDR Gold ETF has a negative 0.528 correlation to the Powershares DB US Dollar Bullish Fund (NYSEMKT:UUP), an ETF that pools together investors money to invest in the U.S. Dollar.
How much can gold's negative relationship to the U.S. Dollar come in handy during periods of inflation? Consider that when inflation was rising at a double-digit rate between August 1976 and January 1980, gold prices increased by over 700%.
Inflation isn't the only reason why a currency's value may decline, though. The global currency market is the biggest market in the world and currency exchange rates fluctuate widely based on each individual countries economic data and political stability. Because of this, the value of the U.S. Dollar may decline if other foreign currencies are viewed as better investments. In such a scenario, gold's negative correlation to the U.S. Dollar means its value could increase as the U.S. Dollar falls, providing investors with gains despite the Dollar's drop.
No. 3: Peak gold production could send prices higher
Improved mining and discovery techniques helped global gold production increase to 3,150 metric tons in 2017, up from 2,470 metric tons in 2005. However, there's only so much gold in the ground and it's commonly believed that we're closer to peak gold production than we are far away from it.
This thinking was reinforced last year at the Denver Gold Forum when World Gold Council Chairman Randall Oliphant said gold production is plateauing.
If he's right, then an eventual return to declining year-over-year gold production and the resulting effect of tightening global gold supply, could translate into higher gold prices if gold consumption for things like electronics connectors and jewelry, plus demand from Central Banks, outstrips new supply.
The impact of peak gold on prices might not be limited to the commodity itself, either. As gold companies fail to replace their reserves with new discoveries, consolidation within the industry could drive valuations up for gold companies boasting the best reserves. For this reason, having some gold or gold stocks stashed away in your portfolio could be profit-friendly.
No. 4: A dash of income
Gold stock prices are volatile and that makes investing in them risky. Nevertheless, some gold stocks return some of their quarterly profits to investors in the form of dividend payments which makes buying gold stocks attractive.
This is particularly true of gold royalty and streaming companies, such as Royal Gold (NASDAQ:RGLD) and Franco-Nevada (NYSE:FNV). These royalty companies provide gold mining companies with the funding they need to buy and develop their gold mines. In exchange for their financing, these royalty and streaming companies can receive royalties on future gold revenue or the physical gold itself. This business model has been a boon to income investors because as these deals pan out, it provides a steady stream of cash flow that can be used to boost dividend payments to investors or reinvest back into new deals. For example, Royal Gold's dividend payment has grown by 257% and Franco-Nevada's dividend payment has grown by 95% since 2010.
The potential for ever-increasing dividend payments makes royalty and streaming gold stocks enticing, but you might want to keep some of your enthusiasm in check. Although these companies dividends are increasing, their dividend yields, or the amount you'll receive in dividends divided by the stock's share price, are low. Royal Gold's dividend yield is just 1.19% and Franco-Nevada's yield is only 1.35%, as of this writing. Those yields won't offset much of a sell-off if souring gold markets lead to a sell-off in either of these stocks.
No. 5: Investing outside of the banking system
The U.S. banking system is one of the most stable in the world and thanks to the Federal Deposit Insurance Corporation (FDIC), bank accounts are insured up to $250,000.
Nevertheless, there's always a risk that a crisis could strike that imperils the banking system in a way that makes owning an asset like gold outside of the traditional banking system worthwhile. Owning physical gold would likely be the best way for you to own gold to protect yourself from such an event, however, owning physical gold can be expensive. Sure, you can store gold in your home or bury it in your backyard, but that's risky in and of itself. To protect against theft or loss, paying storage fees to hold it in a gold depository and insuring it is best.
What you should know before you buy gold
While buying different types of investments that aren't highly correlated can diversify you against volatility, you should know that previously uncorrelated investment types, like U.S. Treasury bonds and stocks, have become increasingly correlated since the Great Recession.
The change in the relationship between those two investment types over the past 10 years is a good reminder that correlations aren't set in stone. Correlations over short time periods may differ significantly from correlations over long time periods and that means that there's always a risk that if you buy gold, it may move more in lockstep with your other investments then you planned.
Also, it may be helpful to know that while gold's correlation to stocks is relatively weak, gold is more strongly correlated to long-term U.S. Treasury bonds. Therefore, if you're a fixed income investor who buys U.S. Treasury bonds to generate stable income, adding gold to your portfolio may not give you the same benefits of diversification that it would in a stock portfolio.
How to buy gold
If you're ready to add some gold to your portfolio, you have three common options to get exposure to this precious metal:
You can buy physical gold from a dealer, but they'll charge a markup. You'll also want to pay to store your physical gold and you might want to insure your gold, too. Physical gold may also be more difficult to sell than other options and if you sell it to a dealer, you might not get as much for your gold as you'd like.
If you buy a gold ETF, then your investment will be pooled with other investors money to buy physical gold that the ETF fund manager will arrange to have stored and insured. A gold ETF will charge you an annual expense ratio to cover those costs, but oftentimes, that expense ratio will be lower in percentage terms than the costs you would incur directly if you were to buy and hold physical gold. For example, because the iShares Gold Trust ETF (NYSEMKT:IAU) can leverage its size to negotiate favorable terms, it's expense ratio is only 0.25%.
To buy a gold ETF, however, you'll need a brokerage account and that broker may charge you a commission to buy and sell your gold ETFs. Nevertheless, because gold ETFs trade intraday on public stock exchanges, they can be bought and sold quickly, and that makes them arguably the simplest way for you to buy and sell gold.
The riskiest of these three investment options is buying gold mining stocks. Mining for gold is expensive and gold prices are unpredictable, so the profitability of gold mining stocks can vary widely from quarter to quarter. Some gold mining stocks have lower costs and better gold reserves than other gold mining stocks, so you'll need to spend a lot of time considering what gold stocks you want to own before pressing the buy button.
How much gold should you own
There are pros and cons associated with owning gold, but if you've decided to include gold in your portfolio, you're probably wondering how much gold you should buy.
The amount of your net worth you invest in gold will depend on your personal situation, however, most investment advisors recommend only having a small proportion of your portfolio in precious metals. In 2017, billionaire investor Ray Dalio, the founder of the fabled hedge fund Bridgewater Associates, indicated that a 5% to 10% position in gold could be prudent. I think that's a sensible amount of gold to own for most investors.