A Tough Year For Gold, But Positives Ahead

FuturesIt has been a disappointing year for gold investors in 2015 so far with gold gradually declining since the beginning of the year. Investors may be getting sick of the yellow stuff after the 2014 performance of gold going nowhere, and then the drop in 2013. However, it is during such times that it is important to review the reasons for owning gold and keep its performance in perspective. In this article, we will review the performance of gold, look ahead at the financial landscape, and review whether holding gold still makes sense.

Gold Continues to Outshine, Despite Short-Term Performance

Gold is currently down around 10% year-to-date, bringing its one-year performance down to about the same at -11%. The current price of $1,070 hasn’t been seen since November of 2009. The five-year performance of gold is now down around 21%. This comes after 2014, where gold was essentially flat for the year, and 2013 where gold was down around 28% after correcting from its big run-up to $1,900 an ounce.

Periods of poor performance are certainly painful, and years of poor performance can seem excruciating in the short-term. However, gold as an asset must always be viewed in longer time frames and should always be compared to the other options. From 2001 through 2012, gold had positive gains, with eight of those years showing double-digit gains.

The ten-year performance of gold is up 116% and the fifteen-year performance is a positive 303%, compared to the S&P 500 which is up only 65% and 55% respectively! Gold is clearly holding its own, considering it should be an underperformer because it doesn’t represent a business or return a cash flow.

Remember What Gold Is and What It Isn’t

Many readers of this site are familiar with the reasons for holding gold as a portfolio diversifier and the importance of considering it as an alternative currency, a form of insurance, and as a hedge against inflation. Yet it still helps to be reminded of these reasons, especially when facing lackluster performance and seeing your investment continue to decline in dollar terms.

Gold should always be bought with the intention of holding it for the long haul, never a get-rich-quick idea and certainly not a ‘trade’ to make a quick buck. In fact, you should hope gold only keeps up with inflation or does a little bit better, because if the price of gold explodes, it likely means your other assets and investments such as stocks or real estate are not doing well. This also means gold should be a sizable – but not too big – part of your portfolio, usually 10% to 20% depending on your comfort level.

An interesting chart illustrates this concept well, ranking the returns of major asset classes for each year from 1975 to 2014. In the last 40 years, gold has topped the performance of all other asset classes 5 times, but has come in at the bottom 11 times. Gold’s performance is quite binary: either it does extremely well for the year, or is at the bottom of the heap. Despite this, gold’s cumulative 40-year return of 582% has beaten commodities, inflation, housing and cash! In other words, when it does well, it does very well.  

What’s Ahead for Gold?

Even though gold has given investors a hard time lately, we can see it has handily outperformed over the long-term and seems to be bottoming out and staying above $1,000 an ounce. Looking ahead, gold should continue to react to central bank actions, which in turn are influenced by global growth, and risks of deflation or recessions.

The next big event is the Federal Reserve decision whether to start raising interest rates in December. Most market participants think the Fed will start to raise next month as the futures are predicting a 78% probability of a rate hike. A rate hike is considered bad news for gold as it points to the Fed tightening its monetary policy.

However, the market is always forward looking, and if most people are expecting a rate hike, then that information is already factored into the price of gold and may well be why the dollar has been rising and gold has been declining. Therefore the downside is already baked-in, and if the Fed decides not to raise, it will be a surprise and an upside for gold.

Longer-term, even if the Fed starts hiking rates, I believe it will be short-lived or they will only increase at a snail’s pace. As previously noted, the Fed has everything to lose and not much to gain by hiking interest rates right now. Further, if the U.S. slides into a recession (an increasingly likely scenario in the next year or so), or deflation appears, they will be forced to start printing again, which will undoubtedly be positive for gold.

In conclusion, we have seen some relative short-term pressure on gold, but the fundamentals and reasons for holding gold remain sound. In addition, the near-term factors look to be in gold’s favor as well. If you haven’t rebalanced your portfolio to make sure you have an adequate portion in precious metals, now could be an excellent time.

Chris Kuiper, CFA is currently a student and researcher at George Mason University, pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.