Since the turn of the year, the price of gold has risen by around 21% while other asset categories have delivered far lower levels of performance. For example, the FTSE 100 is down by around 3% year-to-date and with gold now trading at its highest level since January 2015, many investors are becoming increasingly interested in buying the precious metal.
Clearly, gold has performed well relative to other assets in recent months because of uncertainty surrounding the global economic outlook. The transition of China towards a consumer-focused economy has caused great uncertainty among investors. Meanwhile further challenges in the EU and the fact that there will be a new US President elected in the coming months seems to have caused investors to adopt a risk-off attitude. And with gold being seen as a store of wealth, it has been popular as investors sought out defensive options.
Furthermore, gold has benefitted from fewer US interest rate rises than expected. In 2015 the Federal Reserve said there could be multiple rate rises in 2016 and so the price of gold dipped to its lowest level since October 2009 as the market priced-in a tightening of monetary policy. However, doubts have been cast surrounding the pace of interest rate rises following market volatility and so the price of gold has risen to reflect what’s likely to be a more dovish monetary policy from the Fed in 2016 and beyond.
Uncertain future
Looking ahead, gold could continue its performance in the early part of the year if uncertainty regarding global economic growth remains high. However, this doesn’t mean that buying gold is a good idea, since its value is exceptionally difficult to ascertain. As with any commodity, it’s dependent on supply and demand and investors have no way of knowing how either of them will perform in future.
Certainly, the same could be said for investing in any asset, be it shares, bonds, property or anything else. However, the difference between those assets and gold (as well as other commodities) is that it’s possible to seek out a margin of safety with shares, bonds and property as a value can be more easily placed upon them. For example, shares may be trading on a low price-to-earnings (P/E) ratio and bonds or property may have a high yield. Such a margin of safety provides an indication of the risk/reward ratio on offer, while buying commodities such as gold offers little in the way of guidance regarding valuations.
Clearly, resources companies are highly dependent on the price of commodities such as gold and they remain sound places to invest. That’s because, while their profitability is directly affected by commodity prices, they can be analysed in detail regarding their financial standing, valuation and strategy so as to determine if they’re worth buying or selling. As such, they seem to make far better investments than simply buying or selling commodities, which means that even if you’re bullish on gold it may be prudent to buy gold mining companies rather than the asset itself.
