SUMMARY
The precious metal has risen over two-and-a-half times in price since 2015. But the increase hasn’t always followed traditional patterns.
More than most commodities, gold can arouse strong feelings.
According to some of its many admirers, the precious metal represents the “ultimate form of money” and even the “only true variety of money.”
Gold’s also-numerous detractors routinely dismiss it as a “pet rock” – in an investment context, of course.
The great economist John Maynard Keynes famously remarked that gold was a “barbarous relic” insofar as its former use as backing for the monetary system was concerned.
The problem, of course, with strong feelings – and the words that accompany them – is that they can too easily distract from facts.
True believers and skeptics alike sometimes have preconceptions about gold that are not always rooted in evidence – or at least not in a balanced way.
Whatever your stance on gold, therefore, it is important to revisit your underlying case frequently to see if it stacks up.
What is driving up the price of gold?
From the end of 2015 to the end of 2024, the spot price of gold rose around 10.6% annualized.1
(There are many vehicles for investing in gold via equity markets – such as exchange traded funds “ETFs” or mutual funds – that are linked to the underlying spot price. Such exposure is our focus in this article.) How you seek to gain exposure should be part of your discussion with your financial professional.
By most standards, gold’s recent run classifies as a bull market. Over the same period, developed equities have gone up by 11.8% and fixed income by 2.1% annualized.2
But what may be behind this move?
To address this important question, Citi Wealth Investments’ Strategic Asset Allocation and Quantitative Research team has run a series of statistical analyses on the price of gold and various factors that may help explain its behavior.
Inflationary worries
Devotees of gold traditionally emphasize its potential to hedge against inflation.
Over the very long term, the yellow metal may have helped investors to preserve purchasing power.
Since 1900, the U.S. Consumer Price Index (CPI) measure of inflation may have risen by around 3897%.3
The spot price of gold during the period went from $20.97 to around $2643 to the end of 2024, an increase of over 12,500%.4
So, it more than kept up with inflation over almost one and a quarter centuries.
But what about over shorter periods?
Some of gold’s recent bull market has, of course, coincided with resurgent inflation in the U.S. and elsewhere.
U.S. CPI inflation went from a yearly rate of 2.6% in the first quarter of 2021 to as much as 9.1% in the second quarter of 2022.5
In the 1970s, inflation saw even bigger surges, both of which saw gold spike higher.
However, it is worth noting that the current uptrend in gold began somewhat before the recent outbreak of inflation.
In 2019 and 2020, CPI inflation dipped to 1.8% and 1.2%. But the precious metal nonetheless registered double-digit gains in each year.6
In the same way, there have been numerous years when inflation has risen a bit, but where gold has not.
So, while the metal has seemingly done a decent job of keeping up with inflation over time and during short bursts of very high inflation, gold’s recent behavior may not be that much to do with this phenomenon.
The real interest rate
A related factor that can affect gold is interest rates after inflation, i.e., “real” interest rates.
Often, gold has moved in the opposite direction to real interest rates.
So, when real rates have fallen, the metal has tended to rise.
(We measure real rates here as the yield on the 10-year U.S. Treasury Securities minus the rate of inflation implied by the U.S. consumer price index.)
One reason for this is that falling real rates may make exposure to gold look more appealing as an investment.
After all, when real rates fall, cash may lose some of its attraction, as it commands less interest in real terms.
Owning physical gold, which does not pay any income – while also incurring storage and insurance costs – therefore becomes a more competitive option.
Investors may be more willing to gain exposure to gold at such times, seeking to participate in the price appreciation.
This principle also applies in reverse. When real interest rates rise, gold can lose some of its appeal and fall in price.
The early part of the yellow metal’s current bull market did indeed coincide with a sharp fall in real interest rates – figure 1.
Subsequently, though, real interest rates have rebounded but the bull market has stayed intact.
If real interest rates were to come down – and old patterns applied once more – we believe it could conceivably help gold to keep rising.
Figure 1. Gold and real rates have often done the opposite
Source: Federal Reserve Bank of St. Louis, as of Dec 2024. The gold price is measured as its spot price. Real rates are the Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis, Inflation-Indexed. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Past performance is no guarantee of future results. Real results may vary.
Dueling with the dollar
In one of its most consistent relationships, gold has typically moved in the opposite direction to the U.S. dollar.
After all, the commodity is itself priced in U.S. dollars, such that it becomes more expensive for non-dollar investors to buy when the U.S. currency strengthens.
For most of gold’s 1970s and 2000s bull markets, the U.S. dollar was in a firm downtrend.
Today, though, the U.S. Dollar Index is higher than it was back in 2018.
Typically, this might be consistent with gold having fallen.
Once again, history has not been a great guide to recent performance, therefore.
Geopolitical gyrations
Might tensions on the international stage shed more light on gold’s third bull market of the modern era?
Traditionally, investors have regarded the metal as something of a refuge during moments of elevated uncertainty on the global stage.
Figure 2 shows the 12-monthly change in geopolitical uncertainty – as measured by the 12-month change in the Caldara and Iacoviello GPR Index7 – alongside the precious metal’s 12-monthly changes.
Episodes of intense uncertainty – such as the two Gulf Wars and Russia’s invasion of Ukraine – did coincide with higher gold prices.
The 1990s, by contrast, saw a decline in geopolitical risk, the Cold War having decisively ended in the West’s favor.
Gold’s price languished for much of that period.
In the last decade or so, uncertainty has persisted at higher than customary levels, and gold has kept registering gains.
Figure 2. Gold’s appeal during unsettled times
Chart shows spot price of gold and the Caldara and Iacoviello GPR Index. Source: Bloomberg, as of Dec 1, 2024. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Past performance is no guarantee of future results. Real results may vary.
Global demand
Patterns of demand are a further driver to consider. Central banks have been enthusiastic purchasers of gold in recent times and retail investors have been have sought to gain exposure using various investment vehicles.
The former have been seeking to diversify the reserves they hold away from cash somewhat, while the latter have diverse motivations.
As we might expect, strengthening demand for gold has often been accompanied by rising prices – figure 3.
By the same token, decreasing demand has often coincided with falling or stagnant prices.
That said, the relationship isn’t perfect, with the two series sometimes going in the opposite direction, as in early 2024.
Again, this emphasizes that even perfect foresight into the likes of demand would not necessarily lead to an accurate forecast for gold’s price.
Figure 3. Gold demand and price action
Chart shows 12-monthly percentage changes in the spot price of gold and 12-monthly percentage changes in gold demand. Source: Bloomberg and Metal Focus, as of Dec 2024. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Past performance is no guarantee of future results. Real results may vary.
Allocating to gold
Our approach to creating long-term investment plans – or strategic asset allocations – relies heavily on valuations.
Over time, lower valuations have tended to lead to higher long-term returns in the likes of equities and fixed income.
And higher valuations have often given way to lower long-term returns.
However, such an approach doesn’t really work with gold.
After all, the metal does not generate cash flows in the same way that equities, fixed income and related asset classes can.
Creating long-term forecasts of returns is therefore challenging.
This leaves investors more reliant on analyzing gold’s other drivers, such as those we have explored here.
Of course, these relationships aren’t perfect.
And the interplay between them can be complicated. For example, gold’s price may rise despite rising real interest rates because of increasing demand or geopolitical tensions.
So, frequent monitoring is vital to see if what’s worked in the past is still relevant today.
As with all portfolio allocations to a new asset class or sector, it is important to engage with your financial professional for guidance specific to your investment objectives and risk tolerances.
While fraught with uncertainty, taking a controlled and managed approach is still better than allowing feelings and beliefs to guide one’s approach to seeking a portfolio allocation to gold.
