Gold Prices Gone Bananas

In September last year, I wrote in the Berkshire Business Journal that gold can play a valuable role in diversified portfolios. At the time, gold had just surpassed its previous all-time high, climbing to $3,500 per ounce.

Since that writing, gold and other precious metals such as platinum and silver have seen a meteoric price rise, before cratering on Friday, January 30. The gold price spiked to over $5,500 on January 28—a more than 50 percent increase since the article I wrote a few short months ago. Silver’s rise was even more extreme: up 60 percent in less than a month. These kinds of price moves aren’t supposed to happen to hard money.

The end of last week saw a lightning-fast implosion. Gold and silver each fell by double digit percentages in one day. For investors, this kind of move can be disorienting. But it doesn’t invalidate the reasons to hold gold in the first place.

What’s Driving Gold Prices

The narrative behind gold’s meteoric rise remains in place. To summarize, there are many factors driving the increase in gold prices:

• Ongoing budget deficits, which fuel demand for safe havens like gold.

• A weak U.S. dollar relative to other currencies, which makes gold more affordable in other currencies. Gold is a helpful diversifier for foreign investors.

• Outsize purchases of gold by central banks in India and China in the last several years.

• Exchange traded funds (ETFs), which make gold ownership easy to implement in a portfolio.

• The limited supply of gold, unlike the supply of fiat currencies.

• Gold’s historical role as protection against geopolitical uncertainty and financial crisis.

These factors still hold, whether the price of gold is at an all-time high or whether it has just declined by 10 percent in a matter of hours. The question is, does gold still belong in diversified portfolios?

The speed of gold’s recent price swings has understandably rattled investors. A 25 percent rise in a matter of weeks, followed by a double-digit decline in days, feels extreme, particularly for an asset often thought of as stable.

Despite the common sentiment that gold is safe, it is just as volatile as stocks. Volatility reflects how much prices move over short periods of time, and gold’s historical volatility is not far from that of the U.S. stock market. The difference is that investors are likely accustomed to seeing sharp moves in stocks, while we usually think of gold as more steady.  

Gold’s Value as a Diversifier Still Shines

As I have said many times over the years, and again in September, allocating a percentage of a portfolio to gold can still make sense as a means of diversification.

In portfolio construction, gold helps because it can provide returns that differ from other asset classes such as stocks and bonds. Perhaps the best example of this was offered in the 2008 financial crisis. For the calendar year 2008, the U.S. stock market was down by nearly 37 percent while gold was up by about 5 percent.

An allocation to gold during that crisis would have dampened overall losses in a portfolio, perhaps allowing many investors to stay in their seats and wait for the stock market to come back. This is the goal of diversification—when one investment is doing badly, we hope that another is doing a little better. Not everything goes up and down at the same time, and that makes the ride more tolerable.

Gold’s recent price swings have been newsworthy but they are not entirely unprecedented. The case for owning gold has never been about predicting short-term price movements or chasing the latest surge. Instead, gold can serve a specific role in a well-constructed portfolio when held in moderation and as part of a broader strategy. The goal is not for gold to outperform stocks every year, but for it to behave differently during periods of market stress. When that happens, even a modest allocation can help smooth portfolio returns and help investors stay disciplined.

Whether gold can continue its upward trend is impossible to predict. But gold’s historical track record as a portfolio diversifier remains intact. Meaning that an allocation to gold may still make sense, even at historically high prices.

This article originally appeared in The Berkshire Eagle.