The prices of most commodities have fallen so far this year, but gold has been an exception. This fact might seem odd, since gold is often considered a way to protect against inflation and expectations of future inflation have fallen substantially in the last two months. But there are many factors that affect the price of gold, and the ways they interact aren’t always simple.
Some of gold’s recent surge is likely related to fears about the outlook for the global economy. Concerns about slower economic growth have led to lower expectations of both future inflation and interest rates. Though lower inflation might reduce some demand for gold as an inflation bulwark, lower interest rates can reduce the opportunity cost of holding gold (which doesn’t provide its owners with any kind of income from interest or dividends) compared to other investments such as government bonds.
Recent market turbulence probably played a part as well. Gold is generally considered a “safe haven” investment that does well when financial and geopolitical uncertainty increases. The heightened volatility in financial markets this year and the dissemination of “political risk” around the globe therefore likely contributed to the metal’s recent rise.
Yet determining the outlook for gold isn’t as simple as just figuring out whether market turmoil is going to metastasize or subside. Since it’s priced in dollars, gold tends to move in the opposite direction as the value of the US currency. The dollar often gains value in times of financial stress (although it’s fallen slightly so far this year), partially counteracting gold’s “safe haven” effect. And other factors, such as the demand for gold in jewelry and the amount of gold being mined, also matter.
Even during the global financial crisis, the pinnacle of market turmoil, gold wasn’t an unequivocally good investment. After soaring following the collapse of Lehman Brothers in September 2008, the gold price proceeded to collapse by more than 17% the following month. For the entire year of 2008, gold rose by a modest 4%.The upshot is that in some situations gold can play a constructive role in diversifying a portfolio, particularly if you’re worried about a rise in economic, financial, or geopolitical instability. But the gold price tends to be fickle, and trying to guess which of the many factors that affect its price will prove the most dominant in the near term is generally a fool’s errand. Owning gold as part of broad set of commodities within a portfolio diversified among a range of asset classes is the way to get the benefits of owning gold without having to win at that guessing game.