Why Everyone Suddenly Loves Gold (and What Could Go Wrong) (EP.229)

0:28We all need to make smart decisions with our money. stocks are strong at the same time. Turns out that optimism about AI and earnings can coexist with a bid for safety. And so today I'm going to do four things. First, I want to explain what's pushing gold prices higher right now. And I also want to test the idea that gold is a safe haven. We'll spend some quick time looking at gold as inflation hedge. And finally, I will close with where gold fits into a long-term portfolio. So if you like evidence-based breakdowns like this, I do want to remind you that you can sign up for my free newsletter.

1:01The link is at the top of the episode description, and it is the first place that I share resources I believe investors need to be successful. And it goes straight to your inbox every other Wednesday. Now, why is gold rising? Central banks are probably the biggest contributors. And the trend dates back to the pandemic as government debts were swelling and this perception of treasuries being always rock solid, somewhat softened at the margin at least, and central banks began diversifying reserves away from the dollar. And this de-dollarization accelerated even more in 2022 when the U.S. placed economic sanctions on Russia in response to their invasion on the Ukraine, and specifically they froze U.S.

1:42dollar assets held by the Russian central bank. And so the result is, for the first time since the mid-1990s, gold represents a greater percentage of central bank reserves than treasuries or even euro assets. So in my opinion, it's this trend that is the primary driver of gold's outsized returns in 2025. But gold has also benefited from a choppy macro picture and candidly some policy uncertainty. You got shifting tariff policies, questions about how those changes might affect inflation and or growth. You see signs of softer consumer confidence in certain places. and there are these ongoing geopolitical flare-ups.

2:21And when the news flow is unstable, some investors just want an asset that isn't tied to corporate cash flows. And I think this is definitely something that we are seeing play out right now. Lower interest rates in a weaker US dollar are the other factors making a difference. And here's how you think about it. Because gold doesn't pay any interest, its competition is whatever yield you can earn elsewhere. So if rates fall, or if the market expects them to fall, the opportunity cost of holding gold drops, which tends to support gold prices. And as for the dollar, over time, a weaker US dollar has often been a tailwind for gold.

2:57The relationship isn't perfect day to day, but the two frequently move in opposite directions. But as I mentioned at the start, what's most unusual and to me most interesting about some of these dynamics I'm laying out here is that they directly conflict with the vibes in the stock market, where many investors seek transformational upside from AI. In recent history, you tend to see investors buy stocks when they feel optimistic and gold when they're feeling nervous. Yet here we are with major stock indexes at or near all-time highs, while gold has punched through$4 ,000 per ounce for the first time.

3:33And as I look at those two things, it's just like a rare split screen between animal spirits and equities alongside this growing appetite for protection. And which narrative wins out remains to be seen. But we do know that equities are good for capturing upside. But I have to ask, is gold a good safe haven asset? I've personally always seen gold as somewhat of a panic room, a place where investors can rush when the world feels unstable. And in my experience, when markets stumble or headlines scream crisis, some investors just take comfort in putting money in something that is tangible and they feel like they're more in control.

4:10But history shows that gold's safety depends heavily on when you seek refuge. Over long stretches, gold has tended to behave like a pendulum and recent research, which I will link to in the show notes at thelongterminvestor.com, shows that gold's price when adjusted for inflation often drifts back to its historical average. So in periods when the real price has soared well above that line, as it did in 1980 and again in 2011, future returns have typically been disappointing. And as you'll see in the research, those peaks were followed by years, even decades, of lackluster results. So with gold now trading near record highs in real terms, it's hard to call today's level safe.

4:54And speaking of safe, gold is much more volatile than its reputation suggests when people incorrectly talk about it as a safe haven asset. And since the 1970s, its price swings have actually been larger than those of U.S. stocks. Now, I mention the 1970s because that's when gold futures started trading, and the whole idea of it being an inflation hedge sort of broke down at that moment. But let me just come back here to this safe haven idea. A safe haven that can fall harder than the risk assets it's supposed to offset isn't really a haven. It's simply a different kind of risk. The real problem I have with gold, though, is that it does not do anything.

5:32It doesn't generate earnings or dividends. It just sits there. And maybe it can help preserve purchasing power over long periods, but it doesn't build wealth. So that purchasing power and its ability to hold it over long periods, hundreds of year periods. There's this classic chart that shows how the cost of a suit in gold has maintained the same for several hundred years. That's all fine and well, but if gold were truly an inflation hedge, this year's results would look a lot different because inflation has eased from its post-pandemic peak, yet gold prices have soared. And that disconnect alone is a good data point in gold's poor ability to hedge inflation.

6:13But what sometimes surprises people is that this disconnect is not you, and it's actually usually how gold behaves. Gold often rallies when investors expect inflation to rise, not when inflation is actually running hot. And that's really important because once the fear fades or prices stabilize, gold's returns tend to cool off too. So in other words, gold reacts more to inflation anxiety than to inflation itself. And when you look across history, gold's purchasing power record is mixed because there are many decades where it has roughly kept pace with inflation, but it is not consistent and it is certainly not efficient.

6:50As I mentioned earlier, particularly true ever since gold futures began trading in the 1970s, you'll see that there are these periods that felt like protection in the moment, but then often give way to long stretches of disappointment once price is normalized. Another problem with using gold as an inflation hedge is its aforementioned volatility. Think about inflation in developed economies. They typically fluctuate by a few percentage points each year at most. Meanwhile, gold's annualized volatility has often been around 20%. So we're talking about something that is roughly 10 times more volatile than the thing it's supposed to hedge.

7:27So when an inflation hedge can swing like a small cap stock, it's not really a hedge. It's a speculation about market psychology. The better course of action is to own productive assets when inflation is high. My friend Nick Majuli recently examined historical periods when inflation runs above 4%, and I will link to his analysis in the show notes at thelongterminvestor.com. And what he found was that public equities in real estate have delivered positive real returns. And to me, that makes sense because businesses can raise prices, grow nominal revenues, and over time, protect margins, whereas real estate is able to adjust through rents and replacement costs.

8:06In contrast, Nick's analysis shows that gold's real returns during these high inflation periods were negative. So is gold a good inflation hedge? History says no. It may pop during a scare, but it hasn't reliably grown purchasing power once inflation actually bites. So as you can tell, I'm not a fan of owning gold. And if there is an argument I'm a little open-minded about, it's a strategic long-term allocation held for diversification purposes. Now to be clear, I do not love it as a long-term strategic allocation, but I can at least understand why some people do. The reason I don't love it is simply because diversifying assets are very difficult to maintain with discipline over multiple decades.

8:48I've watched investors grow uncomfortable with decades of international underperformance versus U.S. stocks, and I've also witnessed investors squirm in response to the fluctuation of a TIPS fund, which, by the way, are really great diversifiers within the fixed income allocation. But in both of those examples, you also own those assets because they have positive expected returns and gold does not. So while everyone knows diversification is a good thing, owning something purely for diversification purposes and not also return generation purposes is very difficult to maintain. But if you're still not convinced, I feel obligated to share the framework that I always start with when considering a new allocation.

9:29For me, the weighting is always going to be a starting point of where does it sit within the global market portfolio. And gold falls somewhere between 5 % and 6 % of a global market cap for a portfolio that includes public stocks and bonds, private investments, real estate, and God help me cryptocurrency. So if you are deciding to add gold for the very first time, knowingly at levels that have historically been followed by extended periods of bad returns, then you shouldn't be exceeding the global market portfolio weighting. And be aware that this hopefully long-term allocation and its ability to diversify will be uncomfortable, sometimes for decades at a time.

10:10And it also doesn't replace the heavy lifters of long-term wealth, stocks, bonds, and real assets that produce income and compound growth. As always, thanks for listening. And again, detailed show notes and links to all the resources mentioned at thelongterminvestor.com. 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. Peter 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.

10:53This 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.