golden steps leading up, made of stacks of dollar coins in increasing height
© ieva / 123RF Stock Photo

Investors looking for an inflation hedge or insurance against extraordinary events with low correlation to other assets have long turned to gold, but the strategy is being tested after a down year.

Gold provides “an amazing store of value over time,” said Peter Grosskopf, CEO of Sprott Inc., a Toronto-based investment manager that specializes in precious metals.

“It has done phenomenally well, not just for five or 10 years, but for 30 to 50 years as a store of value compared to currencies.”

Investors have used gold as a hedge against significant downturns or extraordinary market events, as it is less correlated to interest rates or the economy than other commodities, and has very low correlation to broader markets, experts said.

Gold broke the US$2,000 ceiling in August 2020, up from US$1,500 an ounce at the start of 2020. It ended 2020 at about US$1,900 but dropped by about US$100 over the course of 2021.

As equities have been battered to start the year and bond yields have risen, gold has stayed above US$1,800.

A recent report from Richardson Wealth noted that gold went up 18% in 2019 and 25% in 2020, therefore starting 2021 at an elevated price level.

“We don’t know if gold is cheap or expensive as we head into 2022, but we do know after dropping 4% during the year, perhaps it has digested or consolidated after those big previous calendar year returns,” the report said.

“Gold disappointed a lot of people last year,” said Craig Basinger, chief market strategist at Purpose Investments, and one of the authors of the Richardson Wealth report.

But in hindsight, he said the price drop in 2021 made sense.

“If you told somebody you were going to get 5% inflation, most people would have said, ‘Hey, gold is the place to be,’” he said. “And lo and behold, we got 5% inflation and gold was flat. But it’s also worth noting that gold just came off two huge years in a row. I think a lot of those gains [before the end of 2020] were in anticipation of the inflation that we’re now seeing.”

In Canada, inflation rose 4.8% on a year-over-year basis in December, while the U.S. inflation rate increased 5.8%.

Grosskopf called gold the “anti-thermometer,” or the “thermometer of the lack of confidence.”

“There’s been a lot of confidence,” he said, “and now we’re getting into tightening so I would suggest it’s a very opportune time to hold gold.”

Grosskopf said financial assets have been correlated with central bank support and “artificially low” interest rates. As that support disappears and risk returns to markets, gold should do well.

He also noted gold tends to work as both an inflation hedge and a deflation hedge.

“During various cycles it can really act differently, which is why it’s so valuable within a portfolio,” he said.

Gold is also often regarded as a haven when there’s geopolitical risk, which may be relevant as tensions rise on the Russia-Ukraine border.

Claudio Chisani, investment advisor and portfolio manager at Vancouver-based BlueShore Financial, said the price of gold may not change unless a geopolitical event is “extraordinary.”

“The impact of geopolitics [on gold] is often overstated,” Chisani said.

By way of example, he said the price of gold rose about 6% after the Sept. 11, 2001 terrorist attacks, but did not move after the 2015 Paris or after the 2016 Brussels attacks.

“If you have an isolated conflict, if it’s not on U.S. soil, gold may decide to do nothing,” said Chisani.

“I’m not saying that gold does not react to all external events, but they have to be extraordinary events.”

How much of a client’s portfolio should be invested in gold?

It is difficult to say whether there is a particular rule of thumb as to what percentage of a portfolio should be comprised of gold, said Basinger.

“Before you can start to size gold — or bonds or alternatives — you really need to know what the other pieces [of a portfolio] are,” said Basinger.

For his part, Chisani pegs the general rule of thumb as 5% to 10%.

“Lots of people have done the math, and gold within the range of 2% to 10% within a portfolio improves performance as to diversification and reduces risk,” said Grosskopf.

Clients can invest directly in gold by purchasing bullion or gold exchange-traded funds, or indirectly in gold-related stocks such as mining firms. Basinger said the equities have “a bit more volatility” than the bullion itself.

Some investors have touted cryptoassets as an alternative to gold, but experts warned that assets such as Bitcoin do not have the same characteristics or risk factors as gold.

As the recent Bitcoin sell-off demonstrated, cryptoassets may behave more like growth assets than a defensive ones such as gold.

“You can call [Bitcoin] a lot of things but ‘safe haven’ is not one of them,” said Paul Wong, market strategist at Sprott.

“Anything that drops 50% is not a safe haven asset,” said Wong. “Bitcoin is probably one of the most volatile things on the planet.”

Basinger said he’s a fan of crypto as a “speculative growth” asset but that it’s “not grown up yet.”

“At some point, digital assets could be considered real assets and could be considered a true diversifier,” said Basinger.