Gold has a long history as a safe haven because it is largely independent of other asset classes. It has also traditionally been used as a refuge against weakness in the dollar.
The safe-haven reputation in terms of market turmoil is backed by a pretty reliable record. Over longer periods, gold has excelled during bear markets and periods of unusually high market volatility.
Here are the views of Morningstar’s Alex Bryan, director of product management - equity indexes, and Kristoffer Inton, director of basic materials research – equity.
Why is gold a safe-haven investment?
In times of turbulence, like, say, the summer of 2020 when the pandemic was raging and investors were worried about the economy, the price of gold swelled to $2,000 an ounce.
At Morningstar, we use five characteristics to judge an asset's quality as a safe haven. 1) A very liquid market for it. 2) A purpose other than a store of value. 3) Rare. 4) People should want it in the future. 5) It shouldn't degrade over time.
Any other asset competes with gold as a safe haven?
The most competitive asset to gold that could be a safe haven would be U.S. treasuries (Indian equivalent is Indian G-Secs). Treasuries are extremely liquid, permanent, and there is a guarantee of demand. But they don't really have a function outside of investment and the government could issue as many as it wants.
U.S. Treasuries generate return with an interest rate set when they are issued, which means the return is eroded when inflation rates rise. Gold, by contrast, is just a rock, so it doesn't pay anything out, but it tends to maintain its value in real terms during inflationary periods due to its scarcity. Simply put, the gold price tends to rise when the inflation rate is equal to or higher than interest rates, in other words, when real interest rates are low or negative.
Does cryptocurrency compete with gold as a safe haven?
Cryptocurrency has emerged as a competing asset with gold for investors who don’t trust government-issued currency.
Cryptocurrency falls short in a few big ways. It isn't as liquid. It doesn't really have a functional purpose since its acceptance as a currency is still so limited. Since it has only been around for about a decade, it's hard to be sure if there will be demand for it in the future.
Gold has proven staying power and is more likely to be around 50 years from now than any cryptocurrency. Gold still behaves like a safe-haven asset, while most cryptocurrencies are highly speculative.
Is gold a hedge against the stock market and inflation?
Gold is a strange metal. It is a commodity that behaves as a safe-haven asset, largely because of its universal role as a store of value for thousands of years.
Sam Lee, a former editor of Morningstar ETF Investor articulated it well when he said, "The best way to think of gold is as a nonyielding currency with a special trait: The only way to 'print' it is to pull it out of the earth at great cost." Like any foreign currency, the price of gold tends to move in the opposite direction of the strength of the U.S. dollar.
Predicting the movement of any currency or commodity is very difficult, and gold is no different. The best reason to own it is as a hedge against a market meltdown and inflation, rather than as a speculative bet that gold prices will be higher in the future.
Over short periods, gold has been uncorrelated with stocks, but over longer holding periods the two assets have been negatively correlated. In other words, gold has tended to do well in stretches when stocks have fared poorly, and vice versa. For example, during the global financial crisis from October 9, 2007, through March 9, 2009, gold cumulatively gained 25.9%, while the S&P 500 lost 54.9%.
There is no law that this relationship must always hold, and there are no economic drivers to enforce it. It exists because investors perceive gold as a safe-haven asset and use it accordingly. While there isn’t a compelling reason to expect that perception to change, the hedge is only as strong as that perception.
In this way, gold is similar to fiat currencies like the U.S. dollar. Its value depends on others’ faith in it, as there are limited practical applications for it aside from jewellery. The difference is the supply of gold is fairly stable, while central banks can change their money supply at will. This underpins the second reason for owning gold: to hedge against inflation.
Like most commodities, gold prices have been positively correlated with inflation, but they don’t move in lockstep with inflation. Gold can and has lost purchasing power over decade-long spans, as it did between August 1993 and December 2005. Investors who bought gold at its record high real price in January 1980 are still waiting to be made whole on an inflation-adjusted basis. Gold is clearly not a perfect inflation hedge, though it can help boost returns in inflationary periods.
What about the Opportunity Cost of gold?
Gold doesn’t yield anything, so there’s an opportunity cost to own it. The lower interest rates are, the lower that opportunity cost is. Consequently, in the U.S., there has been a strong inverse relationship between real (inflation-adjusted) interest rates and the real price of gold, like most bonds. Because current prices and future returns move in opposite directions, the expected returns on gold are positively correlated with real interest rates, even though gold yields nothing.
Low interest rates inflate gold prices but depress future returns.
Rising interest rates hurt gold prices by increasing the opportunity cost of holding it. So a bet on gold is also a bet that real interest rates will remain low.
Because real interest rates are near record lows, it’s not surprising that real gold prices in U.S. dollars are near record highs. Viewed in this light, gold is far from a screaming buy. Although its long-term real returns will likely be lower going forward, gold may still be worth considering. It’s not perfect, but it can still serve as a hedge against tail risk and inflation.
Is gold worth having in a portfolio?
Gold is not a productive asset, so it doesn’t generate any cash flows. It’s only worth what someone else is willing to pay for it.
There’s evidence that gold can serve as a hedge against a market meltdown and inflation, so it may serve a purpose as a small position in a diversified portfolio.
It’s better viewed as an insurance policy than as a core holding. Investors who decide to add gold to their portfolios should be wary of the hype and be prepared for periodic dry spells.
Having said that, insurance doesn’t boost expected returns. Rather, it tends to reduce them. There is no compelling economic reason to expect gold to provide strong real (inflation-adjusted) returns over the long term. Gold is far from a perfect hedge against inflation and market tail risk. But then again, nothing is.
Where do you see the price of gold?
When economic conditions normalize, we expect prices to fall to about $1,300 an ounce in today's dollars.
