Amid the Covid-19 pandemic, record-low interest rates and massive amounts of government spending have investors worried. Not only this but stock markets are hitting record highs and are being called “expensive”.
As a result, many of us have been seeking out assets that hold their value over time. Cash clearly isn’t one of them.
Granted, I prefer stocks as a long-term investment but is there merit in considering adding exposure to the “yellow metal” (aka gold) to your portfolio?
The spot price of gold rose around 25% in 2020, to close to US$1,900 per ounce. That’s the best year of returns for gold in a decade.
Why the gains?
Gold has been a very divisive topic within investing. It’s usually split between those bears who believe it’s intrinsically worth nothing (you can’t value it) and those “goldbugs” who are extremely bullish on the yellow metal as a viable hedge against inflation.
I think that the truth probably lies somewhere in between, at least in the new normal investors find themselves in.
According to McKinsey, governments globally have provided fiscal support in the region of a whopping US$10 trillion in just the first two months of the Covid-19 pandemic. Out of this, a sizeable portion comes from the US which is a big reason why the dollar has weakened.
Clearly, this has investors worried about the potential economic repercussions of such a large stimulus. The first thought after a stimulus of this size would be that rapid inflation would naturally follow.
However, many economists have pointed out that complete “demand destruction” (i.e. nobody is going out to eat, shop or travel for a while) means that inflation will likely remain tempered in the near term.
With a vaccine now developed and being distributed, though, that could soon change.
What does gold give you?
Any exposure to gold is traditionally thought to provide a level of protection to portfolios that are mainly in stocks.
What’s more, investors buy it as protection against any surge in inflation given it holds its value and there is a finite amount of it in the ground. In this sense, it’s unlike cash, which can be printed whenever central banks feel like it.
True to form, gold‘s spot price saw a resurgence in buying during the Global Financial Crisis and hit its 2012 peak before steadily falling.
It was no coincidence that this coincided with the early stages of a 10-year bull run in US stock markets.
Once investors realised that the much-feared inflation never actually materialised – after massive QE from the Federal Reserve – the gold price started to fall at the end of 2012.
The best way to invest in gold
Ironically, perhaps the best way to invest in gold is to buy an exchange-traded fund (ETF) that tracks the underlying spot price of gold.
Two of the best ETFs to get fast and easy exposure to gold are the SPDR Gold Trust (NYSE: GLD) and iShares Gold Trust (NYSE: IAU).
Both do a similar job in that they actually own the gold bullion required to value the shares rather than investing directly in gold miners.
SPDR is the bigger (and older) of the two and provides more liquidity for investors whereas the iShares ETF is smaller but has a lower expense ratio (basically meaning that investors pay less in fees).
Both have done a good job of tracking the price of gold over the years.
How much gold to hold?
Conventional wisdom suggests that holding a small amount of gold is always wise. Personally, I think that the percentage of your portfolio that should be in gold should be no more than 5% of its overall value.
Some exposure to gold arguably provides liquidity and a defensive hedge if there is larger-than-expected inflation.
Having said that, the opportunity cost of owning too much gold is clearly huge over the long term versus stocks – given the latter’s strong outperformance. That’s something investors should keep in mind.