Gold's Role in Creating a Resilient Investment Portfolio

Author: Kyle Henry

       During times of increased geopolitical tension and global economic distress, many investors turn to commodities to help stabilize and fortify their investment portfolios. The most popular amongst these portfolio fortifying commodity investments is gold. This precious metal is well-known for its capacity to retain value during times of economic and political uncertainty. 

       Typically, investors purchase gold to safeguard against inflation. Gold’s value is not as dependent on the decisions of governments and financial institutions as financial instruments such as the dollar is, making it a reliable value storing medium. As the cost of living rises, diminishing the value of the dollar, gold's value rises, preserving the value of the commodity. This makes gold an effective asset for protecting wealth. Gold and the dollar tend to be inversely related, in that when the dollar's value falls, gold's value tends to strengthen. 

       Gold prices can also move in response to the announcement or anticipation of changes in monetary policy. Market participants actively monitor central banks' pronouncements and forecasts, reacting to any indications of future policy adjustments. With recent Federal Reserve inflation reports and multiple interest rate cuts in the fourth quarter of 2024, aligning with market forecasts, investors reacted to suit. Gold closed at around $2,606.72/oz at the end of 2024 on December 31st, with analysts projecting that the precious metal will hit $3,000/oz by the end of 2025. 

      Gold's appeal to investors is strongly influenced by monetary policy decisions, especially when it comes to manipulating interest rates. When interest rates are lowered, the opportunity cost of keeping non-yielding assets, such as gold, falls, making gold more attractive. In contrast, as interest rates rise, the higher yields available from interest-bearing assets may reduce gold's appeal. Quantitative easing (QE), another monetary policy strategy utilised by central banks in reaction to various macroeconomic situations, entails large-scale purchases of government assets to pump liquidity into the economy and increase the money supply. This increase in the monetary base may raise fears about inflation and currency depreciation, prompting investors to turn to gold as a hedge. 

       Gold is also an effective tool for diversifying one’s investment portfolio, particularly during times of economic uncertainty. A diversified portfolio is composed of financial instruments dispersed across different asset classes to lessen the risk of loss if any one investment performs poorly. Gold, which is well-known for its stability and counter-cyclical tendency, is a strong alternative investment. When the stock market falls, gold tends to remain constant, or even increases in value. For example, the 2020 global pandemic led to a state of panic within global financial markets, driving up gold prices as investors sought protection in the face of uncertainty. This inverse relationship can help serve as a cushion against market downturns. 

       During times of global conflict, investors tend to seek sanctuary in asset ‘safe havens’. Safe haven assets are investments that are projected to maintain or improve their value during periods of market volatility. For millennia, gold has served as the most trustworthy safe haven asset due to its intrinsic value and scarcity. During times of uncertainty, many investors tend to rebalance their portfolios by allocating more of their investment capital towards gold, driving increases in its price. Geopolitical events, such as war and political turmoil, can cause major economic disruption and uncertainty, leading financial markets to higher volatility as investors anticipate possible hazards. During such periods, gold is generally in high demand as investors seek to hedge against probable losses due to a reduction in value of other held assets. For example, gold prices rose sharply in the early days of 2020, as markets feared an escalation of political tensions between the United States and Iran. 

       The amount of gold an investor includes in their portfolio is determined by their own specific investment objectives. As a general rule, it is said that gold should not account for more than 10% of one’s portfolio, as the commodity is not an income producing asset. However, as previously stated, gold acts as an effective hedge against negative macroeconomic situations. Therefore, more conservative and risk-averse investors may be justified in allocating a higher percentage of their portfolio investments to gold. 

       Overall, investing in gold helps to create a more diverse and stable investment portfolio. As economic conditions change, investors can become more resilient to market downturns by hedging themselves against negative market factors by making gold a staple asset in their portfolios.