To many investors, this year is turning out to be a rather complicated year. All asset classes seem confused. In China, the year started with a market rout. In Japan, the frustration of slow growth has persisted such that the country has resulted to negative interest rates. In Europe, the story is the same with Greece in recession and Germany slowing. Mario Draghi recently announced that his committee was considering a stimulus package in March. In United States, Janet Yellen recently stated that the FOMC would not hesitate moving to negative interest rates. Oil is currently trading at about $30 a barrel and the Bloomberg Commodity Index continues to point lower. Amidst all this, there seems to be a silver lining in two areas: bonds and gold. In the United States, near and long term yields have continued to do well considering of the problems we saw in the fourth quarter of last year. Gold on the other hand has done pretty well this year. It’s up 12%. So, should you invest in gold this year?
A safe haven
Gold and treasuries are viewed by investors as safe havens. This means that when the other asset classes are being battered, investors will tend to put their money in gold. This is because of the historic perspective of gold. In a large sense, gold is viewed as a store of value. In addition, gold is viewed as a currency that cannot be manipulated by interest rates or other externalities. Treasuries are considered safe havens because they are usually backed by the United States government which cannot default on its debt obligations. Therefore, these two assets have gained while the rest of the market is having challenges this year. In fact, a close look at the correlation between gold and all the main indexes shows that weakening of these markets has strengthened gold.
The correlation between gold and the United States dollar has for long been a topic of discussion. The theory is that a strengthening US dollar tends to lean gold prices down while the weakening of the dollar pushes it up. The idea is that when the dollar is weak, investors will put their money in gold so as not to lose value. On the other hand, if the dollar strengthens, investors tend to sell gold so that they can be secure in the dollar. Below is a weekly chart of the dollar and gold.
For centuries, gold has played an important role. In religious books such as the bible, gold has been viewed as an important commodity. Today, gold is viewed as the most important item one can own. However, critics argue that investing in gold is a mere ideological thing for a number of reasons. One, gold does not produce any income (like a company does). Secondly, gold does not pay any dividend. Last, gold does not have massive usage like oil does. Gold is used in the manufacture of luxury goods such as jewellery.
Critics have argued that gold has not always acted as a good hedge. In fact, critics argue that gold lost value in 2008 during the recession. This was the time when its real value would have been discovered as investors bought more of it.
As a trader, this year provides excellent opportunities to trade gold. This is largely because of the psychological issues that gold has with investors. When the other asset classes such as equities fall, it is prudent to hedge with gold. So far, this has proven to be a really helpful to me and to many traders who have used this strategy.