Safe Haven Assets: Does Gold Really Hold Up?
When economic times get tough, there’s one asset investors run to more than any other – gold. The glittery metal is viewed as highly defensive, since it tends to hold its value and preserve wealth, while stocks and fiat currencies like the dollar can fluctuate.
Investors think that gold has an inverse relationship with stocks and the U.S. dollar and act accordingly. But gold’s real value actually stems from inflation, a fact that tends to get lost in the background against the cacophony of Wall Street. When it comes to gold as a safe haven asset, there are a number of things to consider before judging its performance.
What gold does for investors
It happens all the time – the markets start to fall, economic data comes in weaker than expected, or geopolitical tensions rise. The first thing investors look to during these times is gold. The precious metal isn’t incorruptible, but as a physical commodity, its value holds strong relative to other assets.
But gold isn’t an asset that really appreciates over time, unlike stocks. Gold acts as a wealth preserver, holding value steady when all other assets move up or down as the economy performs. Gold doesn’t produce anything or pay interest, it only holds the value of the investment relative to inflation.
But a down market isn’t enough to make gold valuable. It’s real worth needs to assessed relative to inflation and interest rates. Inflation eats away at the power of currencies like the U.S. dollar. In order to compensate for that loss, investments or interest rates must outperform that rate or investors will experience a real net loss.
If interest rates are higher than inflation, there’s no danger to losing purchasing power and gold won’t help any more than conservative investments, like bonds and U.S. treasuries. But if inflation is higher than interest rates, then investors will experience a loss, even when invested in safe assets. This negative environment is where gold’s true worth really shines through. Because gold is tied to inflation, even if interest rates get swallowed up by inflation, money held in gold will stay the same relative to inflation. Gold will be the outperforming asset in this situation.
Keeping a small percentage of a portfolio in gold at all times can be a good defensive strategy. Sudden economic downturns, especially black swan events, can erase gains in a portfolio very quickly. Having a small amount invested in gold means stability for at least a small portion of one’s holdings. When inflation comes on suddenly, markets often experience a sharp downturn with bonds and treasuries lagging behind in both face value and yields. Investors who need a conservative approach who may be approaching retirement will be able to make withdraws from gold holdings, which haven’t lost value due to inflation.