The price of gold is up by roughly 33% so far in 2020, using SPDR Gold Shares (GLD 1.91%) as a proxy. The broader market is only up about 3%, so that's a pretty impressive run. Some analysts are now calling for the metal, which recently hit new record highs of roughly $2,000 an ounce, to go as high as $3,000 an ounce. That's another 50% jump from today's record levels. Is this a gold bull market or is the precious metal space looking at a bubble?
A strange time to be an investor
The financial markets are in an odd place today, with terrible economic news driven by the global COVID-19 pandemic. The recent uptick in cases in countries around the world, including the United States, shows pretty clearly that the risks that the coronavirus poses are hardly over. So, on some level, a gold rally makes complete sense. The metal is often seen as a safe haven investment into which investors flock when the market is doing poorly. Only the market isn't doing poorly today. In fact, the S&P 500 Index is trading near record highs after a very short bear market earlier in the year.
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That said, it is possible that investors are shifting into gold in anticipation of a sharp market drop. That wouldn't be an unreasonable move given the economic and health backdrops today. However, it could mean that gold is, to paraphrase an old Wall Street saying, rallying on a "rumor" and that it might then get "sold" on the news. If you look back to the bear market at the start of the 2007 to 2009 recession, that's pretty much what happened.
As the market sold off SPDR Gold Shares rallied about 25%. But then they fell nearly 30% from that peak as the broader market continued to fall. That is a big drawdown that would be difficult for many investors to hold through, particularly ones that hadn't been through a bear market before (more on this in a second). Yes, gold performed better than stocks, but the historically volatile precious metal is known for swift and and often dramatic price swings and it didn't disappoint. To be fair, gold went on a huge rally following that drop, along with other commodities, driven by the story that Chinese demand would grow for years. But, after hitting record highs in 2011 that story unraveled and gold fell until mid-2016.
Today's crazy market
Which brings the story back to the present market, which is far from normal. With the advent of free trading, often novice investors are "investing" in historically dangerous ways. It's worth looking at this a little more closely. Robinhood, which helped to usher in the free trading we see today, has seen its customer account numbers go from 1 million to 10 million since 2016, according to CNBC. The median age of its users is 31, which means that half are older and half are younger. In other words, a very large percentage of its customers were alive, but were highly unlikely to be investing during the 2007 to 2009 recession and associated bear market. They really don't know what it's like to live through serious stock market pain.
In fact, investors today are doing some things that don't make logical sense. For example, investors drunk on free trading, which has spread to other discount brokers, have been bidding up the price of bankrupt companies. In most bankruptcies stock investors get wiped out since they are generally the lowest level creditor. This trading trend has been so pronounced that Hertz was looking to issue shares while it was working through bankruptcy, noting in its SEC filing that the shares would probably end up worthless. The SEC rightly squashed the idea, thankfully, but that the company even brought it up is somewhat shocking and a statement to the crazy state of the market.
What seems to be going on is that novice investors are simply jumping on any hot story that they see. For example, when news broke that Eastman Kodak would be receiving a government loan to produce pharmaceutical ingredients the stock rallied massively. In a single day some 60,000 Robinhood customers added the name to their portfolios to jump on the bandwagon. There were likely many more who did the same thing at other brokers, as well.
This type of activity sounds more like gambling than investing. Which is exactly what some new traders may be doing, since they have been locked out of sports betting and casinos because of COVID-19. This notion has been suggested in trade publications from Barron's, in the finance sphere, to Sports Illustrated, on the sports side of the equation. Novice investors looking for the thrill of gambling sounds like it would lead to investors jumping from "story" to "story" in search of the next big win.
Gold's dramatic move higher in recent days, with the metal reaching new highs, is a pretty good story to latch onto. Since July 20, SPDR Gold Shares have rallied about 12% compared to a 2.5% advance for the S&P 500. That's a very big move in a very short period of time and should result in long-term investors hitting the pause button here. Worth noting is that industry trade group The World Gold Council highlighted that the demand for gold is down sharply across the board (roughly 45% in the case of jewelry, a key demand source), except from ETFs. In other words, this rally is being driven by investors using ETFs to trade. There's a very real possibility that gold is in a bubble that could easily burst as soon as inexperienced investors find a better trade. Caution is in order.
The big takeaway
Adding gold to a portfolio for diversification purposes isn't a terrible idea. However, now isn't the time to make an aggressive bet on the metal or companies that mine for it, which tend to move even more dramatically than the metal itself. If you must buy gold today, make sure you think about the downside risks so you don't get caught up in the idea that this tree is going to grow to the sky -- which another Wall Street saying will inform you never happens.
