Gold is often looked at as a safe-haven asset. When Wall Street starts to crater, investors jump into gold in an attempt to limit the pain. Today, in the middle of a global pandemic, the metal's role in investing would seem to be more important than ever -- but there are some very mixed signals out there. Before you decide to buy gold today, consider these three issues.
1. What a run!
Using SPDR Gold Shares (GLD -0.69%), an exchange traded fund (ETF) that owns physical gold, as a proxy, gold has rallied by roughly 33% since hitting a low in roughly mid-March. Gold miners, which are generally tied to the price of the precious metal, have advanced even more than that. VanEck Vectors Gold Miners ETF (GDX -0.61%) has roughly doubled over that span. VanEck Vectors Junior Gold Miners ETF (GDXJ -1.15%), which tracks smaller miners, is up 140%.
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To be fair, precious metals have a history of being volatile and prone to swift and often material price swings. But these are very large changes in a very short period of time. They suggest that investors are worried about the stock market.
However, with such a material run already in place, investors need to ask themselves how much more upside is actually left. In fact, over the last week or so, gold and silver have seen particularly swift advances. And all of this time the S&P 500 Index has basically continued to head higher. To me that doesn't feel quite right. It could indicate concern on the part of some investors, but it also makes me fear that investors are buying in anticipation of a bear market (the rumor), which might lead to profit-taking when one arrives (the news). After all, "buy the rumor, sell the news" is an old Wall Street saying that proves true with frightening frequency.
Add in the unusual trading activity that's been taking shape today in highly risky stocks, notably those that have gone bankrupt like Hertz, and there's even more reason to think that the gold market might be heading for choppier waters. Remember that stock investors are usually wiped out in the event of a bankruptcy. Traders, drunk on free commissions and leverage, have done very strange things while stuck at home because of COVID-19. Some have even suggested that without sports to bet on, or casinos to frequent, Wall Street has become the best way for thrill-seekers to get their kicks. It's a topic that publications from Barron's (in the investment space) to Sports Illustrated (in the sports area) have covered. If that's true, and precious metals are the current fad, the outcome could be ugly.
2. It's about diversification
The thing about gold is that it shouldn't be seen as a get-rich-quick investment. The real benefit gold offers investors is its ability to diversify a portfolio. A small amount of precious metal exposure held over the long term can help to smooth out the ups and downs along the way.
So if you are looking at gold or gold miners today because of the huge price runs here, you are likely looking at these investments for the wrong reason. If you are worried about the current level of the stock market, however, and think that now is a good time to add some diversification, you are on the right track. However, based on the swift price run that's already in the rearview mirror, you might be a little late to the party. Adding gold now could backfire.
Take the 2007 to 2009 recession as an example. Sure, gold outperformed the S&P 500 Index, but it still lost value. And it fell more than 20% from its peak at one point in the span. That would be a tough draw down to live through if you were expecting to see further gains.
That brings up point three: cash.
3. Cash is probably safer
At the end of the day, cash is likely the safest of the safe-haven assets you can own. If you are worried about the stock market, it's probably better to stash some more money in cash than it is to buy gold after an already swift and material price advance. Cash won't do much for you in today's low interest rate environment, and inflation will eat away at its value over time, but it will keep you from losing money if the stock market falls sharply. And if a bear market does show up, you can put your cash cushion to work.
As a compromise, you might consider using the money you would have put into gold to augment your cash position. That will provide extra safety now, and when gold prices have pulled back from their rapid ascent you can reconsider adding some precious metals exposure without the risk of getting caught up in the current gold hype.
Buy gold, but maybe not today
Gold has a place in most portfolios, but you need to be careful about how you use it. If you already have a long-standing position in the metal, you should probably stick with it. But today's swift rise seems to have taken on a life of its own. That makes sense given the difficult times we face today, which have altered the investment landscape in a potentially negative way (notably by increasing the ranks of speculative traders). But if you are looking for a safe haven, cash is probably the better call.
Don't give up on gold -- just keep it on the wish list for now if you are looking to initiate a new position. The risk/reward relationship appears skewed toward risk for the moment.
