With the rising tensions between the United States of America and Iran, gold and the SPDR Gold Trust ETF (GLD) have gained about 6% within just a few trading days, which is quite a lot for the precious metal. After gold rallied from $1,270 in May 2019 to about $1,550 in August 2019, the price was in a corrective phase in the months following August. Due to the geopolitical situation and the looming military conflict between the United States and Iran, that corrective phase ended very suddenly.
While a military conflict is bullish for gold, there are several other reasons, which are not only bullish for gold, but don’t come with such a high price. In the following article, I will argue once again why gold is a good long-term investment right now. Not only have we seen a solid performance during the last decades, gold will diversify any portfolio and with the central bank buying gold at a higher pace, the demand is still high. But we start with a look at the performance in the recent past.
2019 was one of the best years gold had in its recent history. The annual return of gold was 18.43% and more than double the average, annual long-term performance since the 1970s. But compared to the stock market, gold was only a second-class investment as the S&P 500 (SPY) could gain even 28.88% last year.
Since the lows in mid-December 2015, gold could increase more than 40%, but was once again outperformed by the S&P 500 which could gain 58.31% in the same timeframe. And although it might seem right now, that gold is always underperforming the stock market, that is not necessarily true. When looking at the performance of gold during the last 50 years compared to the Dow Jones Industrial Average (DIA) or the S&P 500, gold could return almost 4,300% while the S&P 500 and the Dow Jones Industrial Average could return only 3,600%. This is resulting in an annual average return of 7.44% for the S&P 500 and Dow Jones Industrial Average while gold had an annual average return of 7.8%.
But one might point out that the S&P 500 and Dow Jones Industrial are price indices and not total return indices and therefore a comparison between gold and those two gives gold an unfair advantage as an equity investor would also receive dividends, which are not included in the performance of the S&P 500 or Dow Jones Industrial Average. When looking at a total return index like the Wilshire Large-Cap Index instead, stocks would have returned about 13,100% in the last 50 years (including dividends), while gold would have gained only about 4,300%, making stocks the better investment. This leads to an average annual return of 10.24% for stocks (including dividend payments), while gold is yielding only 7.8% on average.
After looking at the long-term performance of stocks vs. gold one might ask why an investment in gold makes sense when an investment in stocks would have led to a three times higher amount over the last 50 years. One could think about Warren Buffett, who has a strong opinion on gold, which is expressed in many famous quotes like this:
Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
Buffett is absolutely right, that gold has no utility and it is also difficult to calculate an intrinsic value. Investing in gold (or rather speculating) is based only on the conviction that in future years people will buy gold for a higher price than right now. And considering these aspects, we have to raise the question again: Why should we own gold, when stocks seem to be a better option over the long run.
Buffett vs. Dalio
In my last article on gold, I mentioned another great investor of our time – Ray Dalio – who has a different opinion on gold. While Buffett argues that gold has no utility, Dalio considers gold to be an important asset class that should be part of a diversified portfolio. In Dalio’s “All Weather Portfolio,” gold makes up 7.5% of total assets and as gold is not really correlated to stocks, it is a good addition as this will lower the overall volatility of a portfolio. Although there are times where gold seems to be negatively correlated with equities, there is not really a strong correlation between the two. And the fact that gold is not really correlated with equities makes it not necessarily a good hedge, but definitely a good way to diversify a stock portfolio.
Additionally, gold is also a protection against crisis or against a potential collapse of the monetary system. A collapse would be a dramatic scenario and hopefully not something we will see in the near future (although not impossible), but troubles less dramatic than a total collapse could also be a catalyst for gold.
Central Bank Is Buying
Another reason to be bullish on gold is the fact that central banks keep buying gold and for the first three quarters of 2019, the amount purchased has not only been 12% higher than last year, but it has also been the highest amount of net purchases of gold in the last 10 years. And a rising demand will lead quite naturally to higher prices.
When looking for a reason why central banks started buying gold with such a high volume again in 2018 and 2019, there is a statement from the Dutch National Bank, which might explain part of the reason (and is also a bit scary):
If the entire system collapses, the gold stock provides a collateral to start over. Gold gives confidence in the power of the central bank’s balance sheet. That gives a safe feeling.
But central banks are not the only purchasers of gold and when looking at the amount, also not the biggest.
When looking at these numbers, we can see that the biggest part of the demand for gold is from jewelry (about 50%), which is not fluctuating much. Leaving jewelry aside, the gold demand stems mostly from people purchasing bars and coins (probably as an investment).
Technical Point of View
A final reason to be rather optimistic about gold is the technical picture. In my last article on gold – published in June 2019 – I stated that $1,530 would be the next target for gold. And within a few short months, gold reached that target and was in a corrective phase in the last few weeks. On Monday, gold tried to break out once again, but we can’t really be sure yet if that breakout will be successful. In my opinion, it is possible that gold will expand the current correction and even a pullback to the former resistance level around $1,370 to $1,390 would not be surprising. But in case of rising tensions and a further escalation between the United States and Iran, a successful breakout is also possible and, in that case, gold could climb to its all-time highs from 2011 without major resistance levels in its way.
(Source: Own work created with Metatrader4)
While for the short-term it is rather difficult to decide in which way the gold price will move, I am pretty bullish on gold over the long run. When looking at the long-term performance, we see that the last major bull market started in 2000 and reached its all-time high in 2011. In the following years, gold corrected, but it seems like the correction could be finished and gold might have found its temporary bottom around $1,050. If gold started its next bullish wave, it might last for several more years and we might see gains of not just 42%, but see the gold price double or triple within the next few years (it might go even higher).
(Source: Own work created with Metatrader4)
Confidence in Gold
A final reason making me confident that gold will be a good investment in the years to come is its history, which is showing enough consistency and people valuing gold for a long time. Although it is difficult to say when humans really began to value the precious metal, we have confirmation in the pyramids that in Ancient Egypt (3,000 years ago) gold played an important role (despite it has not been used as money). Gold was probably used as a form of currency for the first time about 550 BC, when King Croesus minted coins in a region, which belongs to Turkey today. And finally, the adoption of the gold standard in the late 1800s really cemented gold’s value in modern finance as most major nations fixed the value of their currency to the gold price.
And not only have people ascribed value to gold over centuries, the performance over the last 50 years (which is definitely a long timeframe) has been solid (see section above). And although there have been periods when gold underperformed for many years (for example between 1980 and 2000), the performance of the last five decades should make us optimistic.
When investing with a time horizon of only a few months, gold might not be a good choice right now as a correction to $1,370 is possible. However, if you are investing with a time horizon of several years or decades, gold should be part of every portfolio. I am quite aware that gold has no utility and it is impossible to calculate an intrinsic value. Nevertheless, the fact that gold had value for most people for centuries as well as the performance of the last 50 years gives me enough confidence that gold will remain a solid investment in the decades to come.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own gold in different forms (physical as well as derivatives)