The Gold Rush—Should You Invest in Gold Now? (EP.195)

0:28We all need to make smart decisions with our money. help you figure out where you stand and what to do next. There's a link at the top of the episode description in your podcast app, or you can go to smartmoneyquiz.com. Gold prices have been surging lately, up almost 10 % year to date and trading near all-time highs at just shy of$3 ,000 per troy ounce. This follows a pretty notable 25.3 % increase last year, which surpasses the S &P 500 total return. But why exactly are gold prices climbing and should investors consider buying gold now? Well, let's tackle that first one first. Why are gold prices rising?

1:10I think the key contributor here are central banks. Following the freezing of Russian central bank assets in response to Russia's invasion of the Ukraine in 2022, global central banks have significantly ramped up their gold purchases with annual increases averaging 11.5 % since 2019. Now, these central banks are primarily buying gold to diversify the reserves and protect themselves against any sort of geopolitical risks and currency instability. The other common narrative supporting gold's recent run is the changing investor sentiment driven by heightened inflation expectations and expansive fiscal and monetary policies.

1:51As interest rates peak and the attractiveness of bonds and cash diminishes, investors perhaps are increasingly viewing gold as a perceived safe haven asset. But before jumping into gold, investors should carefully evaluate these claims. First of all, does gold truly diversify your investment portfolio? There are generally two reasons to evaluate whether you should invest in gold or really any new exposure with your portfolio. And the first is enhancing returns. The second is improving diversification. Now, I don't really know how to beat around the bush here, but the case for gold enhancing returns is non-existent because gold has no earnings or income.

2:32So it's impossible to generate a reasonable expected rate of return to use for building an asset allocation. And so as a result, the case you'll typically hear for including gold in a portfolio is going to be about improving diversification. After all, its price movements differ significantly from stocks and bonds, meaning it has a low correlation in finance speak, a low correlation with traditional investments. And while low correlation might suggest diversification potential, correlation alone doesn't justify gold's inclusion in your investment portfolio. Because volatility still matters. If a low correlation asset is highly volatile, it could introduce more risk to a portfolio rather than reduce it.

3:16And the issue of viewing gold as a diversifier in this context is worsened by the fact that we've already established, and that's that it has no expected rate of return. Now, another common case for gold is that it's touted as an effective inflation hedge, but historical data tells a very different story. Since gold futures began trading in 1975, gold prices have frequently risen in anticipation of higher inflation only to deliver disappointing real, that's inflation-adjusted, disappointing real returns once inflation arrives or fails to materialize. Furthermore, gold's volatility undermines its reliability as an inflation hedge.

3:59From 1970 through 2024, gold's price volatility, as measured by standard deviation, was approximately 18.9 % compared to just 1.3 % for inflation. Now, that is a giant mismatch in volatility and a huge reason that gold is an ineffective hedge on something as stable as inflation. So simply put, despite the popular belief, gold is not an effective inflation hedge. Now, could you be betting against the US dollar and does gold make that the right choice? I think oftentimes investors will turn to gold out of fear of a currency collapse, particularly concerning the U.S. dollar losing its status as the global reserve currency.

4:43But in reality, there currently isn't a realistic substitute for the U.S. dollar, and in the show notes at thelongterminvestor.com, I link to episodes exactly on this topic. The Chinese yuan, for example, represents just a tiny fraction of global settlements and lacks the financial infrastructure necessary to replace the dollar. The Japanese yen and the euro also fall short for various structural reasons, and even those substantial gold reserves held by the U.S. government, famously stored at Fort Knox, are largely symbolic. These reserves remain primarily due to historical legacy rather than strategic necessity, highlighting gold's limited practical utility.

5:26Finally, investing in gold frequently appeals to those concerned about a catastrophic market crash or some sort of systematic failure. However, investing based on fear of the rare catastrophic events essentially equates to market timing, a strategy that we all know historically has proven to be ineffective. And in today's financial environment where cash yields are notably higher, gold's inherent lack of yield means investors face substantial opportunity costs by holding gold. So if we know that market timing is bad, there's going to be a fundamental problem with this argument of protecting against a catastrophic event, even if your hypothetical catastrophic event isn't completely outlandish.

6:09The thing is, we never know when or why the next correction or bear market will happen. What we do know is that market downturns happen on a regular basis. And rather than trying to predict the timing or the cause of the next crisis, you're better off planning on downturns occurring with a similar magnitude and frequency as they have in the past. Investors must be willing to lose money on occasion, sometimes a lot of money, in order to earn the average long-term return that attracts most people to stocks in the first place. Volatility isn't the enemy. Again, just remember, it is the cost of higher expected returns that you earn in stocks versus bonds or cash.

6:49So should you invest in gold? I mean, ultimately, the reason we invest, and I say this all the time, the reason we invest is to outpace inflation without taking undue risk. Rather than chasing trends or emotionally driven investments, you're better served by understanding clearly what it is you own, why you own it, and how it aligns with your long-term financial goals. If you have a thoughtful financial plan and portfolio in place, it probably addresses the concerns that cause you to consider gold in the first place. Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com.

7:35Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.