Gold Prices: What You Can Expect In 2018

Investing

Gold Prices: What You Can Expect In 2018

Stocks are off to a shaky start this year, and many investors are looking to gold as a source of stability in their portfolios. Are gold prices set to shine in 2018?

Published on 13 February 2018

Gold is a perennial favourite among investors. It can help to stabilise your investment portfolio and also act as a hedge against inflation. Since January 2017, the precious metal has gained over 14%.

However, the New York Stock Exchange (NYSE) Arca Gold Miners Index, which is based on the market capitalisation of publicly traded gold mining companies, has fallen by about 1% in the same period.

Is gold still a good investment? Or should you stay away as it has already seen a substantial increase in its value in the last year?

The fear trade

Gold, S&P 500

Traditionally, gold has been viewed as a safe haven asset. Investors buy gold in times of geopolitical uncertainty or stock market turmoil. Frank Holmes, co-author of The Goldwatcher: Demystifying Gold Investing, calls this the “fear trade.”

Holmes says that much of gold’s gain in the last year can be attributed to this reason. Additionally, the low-interest rate environment and the weak US dollar led to renewed investor interest in gold.

With the recent decline in stock valuations, gold could see increased buying as investors sell equities and look for a place to park their funds. In the first ten days of February, the S&P 500 lost about 7%.

Is this merely a temporary aberration that will self-correct soon? Or is it the start of the long-awaited crash.

MarketWatch, a financial information website that is owned by Dow Jones & Company, recently pointed out that the S&P 500 index achieved 12 record highs in January. The previous record for the month of January was 11 new highs. That record had remained unbroken since 1964.

This could have been the frenzied buying that precedes a reversal in the market’s direction. If the downtrend in stock prices continues, it is quite likely that gold will see renewed interest from investors.

The recent Fund Manager Survey from Bank of America Merril Lynch found that 46% of money managers are of the view that stocks are overvalued. That’s the largest percentage to be pessimistic about future share prices since the survey was launched in the mid-1990s.

But despite this gloom about share prices, fund managers remained invested in stocks. The survey was conducted in August 2017, when the S&P 500 was at a little less than 2,500. After that it gained another 300+ points before reversing direction.

Gold’s long-term performance

The stock market has delivered excellent returns in recent times. The bull market, which has been going strong for over eight years, finally seems to be losing steam. But many investors are surprised to learn that gold has provided a far higher return if a longer timeframe is taken into consideration.

Consider the following data:

Gold, S&P 500

In the last 18 years, gold values have appreciated by 366% compared to a rise of only 144% in the S&P 500 in the same period.

However, the picture is quite different if you consider another time period. On 9 March 2009, the S&P 500 index reached 677, its lowest point after the global financial crisis. On that date, gold was trading at US$922. Since then, the S&P 500 has gained 386% to gold’s 43%.

What does that indicate? Simply, that there is no direct correlation between stock prices and gold’s value. While it is true that gold does attract greater investor interest when share prices go down, there is no guarantee that gold will give you good returns if you buy it when stock valuations are depressed.

Supplies are limited

According to World Gold Council data, the total amount of gold that has been mined is 187,200 tonnes. While additional quantities of gold are still produced by the world’s mining companies, goldfields are getting harder to find and extraction is becoming increasingly expensive.

Pierre Lassonde, cofounder and chairman of Franco-Nevada, a Canadian company that has interests in gold and other commodities, says that in the period from the 1970s to the 1990s the gold industry found at least one 50+ million ounce deposit and at least ten 30+ million ounce deposits in each decade.

“But if you look at the last 15 years, we found no 50 million ounce deposit, no 30 million ounce deposit and only very few 15 million ounce deposits,” says Lassonde.

World gold production by year in mines from 2005 to 2015

Gold, S&P 500

Source – Statista

If production volumes plateau, it could have a positive effect on gold prices in the long-term.

The link between oil and gold prices

Gold, S&P 500

Gold’s value is linked to that of other commodities. Roy Jastram’s classic The Golden Constant: The English and American Experience 1560-2007 demonstrated this link.

Subsequently, several analysts have pointed out that historical data show that there is an oil-gold price ratio. This ratio remains constant over extended periods of time. In an article in Forbes, Steve Hanke, who is a professor of applied economics at The Johns Hopkins University, says that this ratio is 0.0721.

Over a period of time, the value of one ounce of gold will be equal to 13.87 barrels of crude oil. To put it another way, the price of one barrel of oil will be the same as that of 0.0721 ounces of gold.

The current price of gold is US$1,318 and WTI crude is at a level of US$64.18. This indicates that over time, either oil prices will rise or that gold prices will fall.

The bottom line

Investing in gold for the short-term could be a high-risk activity that is best left to professional traders.

However, gold should form part of every individual’s investment portfolio. But you should plan to hold it for the long-term.

How much should you invest in the precious metal? Ray Dalio, the founder of Bridgewater Associates, a hedge fund with US$150 billion in assets under management, advises investors to allocate between 5% and 10% of their portfolios to gold.

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