The Strategic Case for Gold During Times of Uncertainty 

As investment professionals seeking to both grow and preserve wealth on behalf of our clients, smart portfolio diversification is a constant pursuit. In times of economic uncertainty, gold has historically proven to be a resilient asset, outperforming traditional equities and providing stability to client portfolios. This discussion explores the strategic advantages of incorporating gold into investment portfolios, highlighting its historical performance during crises and the recent trends of central banks accumulating the metal as a hedge against potential economic downturns.

Sometimes Different is Better

Investing in well-managed companies with great products and services has always been a winning strategy for long-term investors. The same can be said for assets with obvious utility, such as real estate, that offer investors the potential for cash flow and growth. Even certain collectables (e.g., fine art, luxury watches, etc.) can prove to be worthwhile investments, increasing in value over the long run. Then there is that shiny yellow metal that diverges from these characteristics. In fact, gold tends to share undesirable characteristics with short-lived speculative investments: questionable utility with no underlying ability to generate cash. 

Perhaps that is why the intrinsic value of gold remains a point of contention amongst even the world’s greatest investors (e.g., Warren Buffet). In terms of usefulness, gold naysayers have a valid point. With relatively few applications, gold demand, outside of investment and central bank purchasing, has been primarily driven by jewelry demand. However, jewelry alone has never been enough to justify the market price of gold or for the interest it garners from investors and sovereigns alike. In addition, not only does gold provide zero cash flow to its investors, it also often comes with the embedded cost of storing the asset (i.e., negative roll yield). Despite all of this, gold has withstood the test of time and tends to shine brightest in the darkest of times. 

Looking to Gold in Periods of Uncertainty

Historically, gold has outperformed the S&P 500 during periods of economic distress or high uncertainty. When investors flock to gold, it often reflects a lack of confidence in the broader economy and traditional financial assets. In late 2019, Fire Capital did just that by taking a tactical position in gold given our concerns of slowing economic growth, the yield curve inverting, and relatively high asset valuations. While we didn’t know for sure what the future held, we were glad to be in the right place at the right time as gold rallied ahead of the Covid-19 pandemic.

Though, in this case equity markets bounced back quickly (thanks in large part to massive government stimulus), this example helps to underscore the potential value of owning gold as part of a diversified portfolio when uncertainty is high. With gold, unlike for other positioning or hedging, identifying the precise risk is not required to generate positive outcomes. Given that the economic outlook is once again highly uncertain, we have recently added gold positions back into client portfolios. 

Gold Performs Well When Times Get Tough

While the anecdote above looked at a more recent example, below we outline several other notable cases of strong gold performance that either preceded or coincided with economic uncertainty:

The 1970s Stagflation Period

The 1970s were marked by significant economic challenges, including stagflation—a combination of high inflation and stagnant economic growth. During this decade, gold dramatically outperformed the S&P 500. Gold prices soared from $35 per ounce in 1971 to over $800 per ounce by 1980, while the S&P 500 struggled with volatility and inflation-adjusted losses.

The period of gold's outperformance in the 1970s culminated in a recession in the early 1980s. The Federal Reserve, under Paul Volcker, aggressively raised interest rates to combat inflation, which led to a sharp recession in 1981-1982. The S&P 500 struggled during this period but eventually recovered as inflation was brought under control and economic growth resumed.

The Dot-Com Bubble and Early 2000s Recession

In the late 1990s, the S&P 500 experienced a significant bull market, driven by the dot-com boom. However, as the bubble burst in 2000, the S&P 500 entered a prolonged bear market, with the index losing nearly 50% of its value by 2002. During this time, gold, which had been largely ignored during the 1990s, began to outperform. From 2001 to 2003, gold prices rose significantly as investors sought safety amid the market turmoil.

The bursting of the dot-com bubble led to the 2001 recession. The S&P 500 continued to struggle for several years, with economic growth remaining sluggish. Gold's outperformance during this period was a clear signal of economic instability, as investors flocked to safe-haven assets.

The 2007-2008 Financial Crisis

In the lead-up to the 2007-2008 financial crisis, gold began to outperform the S&P 500. By 2007, as cracks started to appear in the housing market and financial institutions began to face significant stress, gold prices started rising sharply. When the financial crisis fully unfolded in 2008, the S&P 500 plummeted by nearly 40%, while gold continued to rise, reaching a peak in 2011.

The financial crisis led to the Great Recession, one of the most severe economic downturns since the Great Depression. The S&P 500 took several years to recover from the losses incurred during this period, while gold maintained high levels for a few years before eventually declining as the global economy began to stabilize and recover.

The European Debt Crisis (2010-2012)

In the wake of the global financial crisis, Europe faced its own set of challenges with the sovereign debt crisis, particularly in countries like Greece, Spain, and Italy. During this time, from 2010 to 2012, gold outperformed the S&P 500 as concerns about the stability of the Eurozone grew. Gold reached an all-time high of around $1,900 per ounce in September 2011.

The European debt crisis led to a period of economic stagnation in the Eurozone, and while the S&P 500 eventually resumed its upward trajectory, the uncertainty during this period led to significant market volatility. The fear of contagion and potential collapse of the Eurozone kept markets on edge, and gold served as a hedge against this instability.

Recent Trends: Central Banks and Gold Acquisition

In 2024, despite significant uncertainty, domestic equity indices keep climbing to record levels. While stocks in the aggregate have performed well this year, gold has performed even better. Given that inflation is generally viewed to be under control globally and the consensus view of the economy remains positive, why is gold outperforming? 

We looked back 100 years and observed that gold outperformed the S&P 500 15 times (not including 2024).  

Excluding a couple instances, the outperformance of gold relative to the S&P 500 coincided with a U.S. recession. In the past, this phenomenon was often seen as a harbinger of economic trouble. It’s questionable if that remains the case in modern times or if there are other factors at play. 

One reasonable conclusion for gold’s recent strength is that demand has significantly increased due to foreign central bank purchasing. The motivations behind this trend include geopolitical tensions, currency depreciation concerns, and monetary policy shifts.

With global geopolitical tensions rising, particularly between China and the U.S. along with regional conflicts throughout Eastern Europe and the Middle East, central banks have sought to diversify away from the U.S. dollar. Gold, with its historical role as a store of value, has become an attractive alternative. In particular, emerging market central banks have been purchasing gold to hedge against potential currency depreciation. By increasing gold reserves, these countries aim to protect their economies from the volatility of fiat currencies. Furthermore, many central banks are anticipating shifts in global monetary policy, especially in light of inflationary pressures. Gold serves as a hedge against inflation, making it a prudent addition to national reserves.

Whether or not increased demand from central banks is the reason for gold’s strong relative performance in 2024, the underlying driver of such behavior is hedging against future uncertainty at some level. 

Conclusion

Assets like gold are challenging to evaluate in terms of timing and value. Some choose to maintain a certain allocation (e.g., 5% of total assets) regardless of the economic outlook. Others stay away completely. At Fire Capital, we are comfortable with the permanent allocation approach in certain client situations but generally prefer to be more tactical when the outlook becomes murky and market uncertainty rises. Allocating to gold provides investors with an additional tool to buffer against losses while maintaining the potential for appreciation even if recession fears abate.