5 Reasons The Drop In Gold Prices Shouldn't Worry Investors
Gold prices took a hit at the end of last week, and it has some observers concerned.
But the truth is it shouldn't be worrying. Here's what you need to know:
Gold bars manufactured in Kasimov. Photo by Alexander RyuminTASS via Getty Images
The price of bullion fell more than $20 a troy ounce between Thursday and Friday, hitting a low around $1,279.
News reports declared, "Gold Solidly Down [...]" and "Gold Prices Take 2% Hit [...] Fresh 2018 Lows."
Here's why gold investors shouldn't worry.
- A 2% move in a day isn't much. If the price fell that much every day for an extended period, then losses would quickly mount, but so far we aren't there.
- Gold prices mostly move down when the dollar gains strength. And it has been strong since January against the world's other leading currencies such as the Japanese yen, the euro, and the British pound. When the dollar gains value, then expect gold prices to fall. Since late January the value of the dollar index versus major currencies has risen by around 5%, according to data from the Federal Reserve Bank of St. Louis. Over the same time period, the price of gold dropped by approximately 6%, according to data from the London Bullion Market Association supplemented with other market data. In other words, the upward movement in the value of the dollar is overwhelmingly responsible for the price moves. This relationship usually works vice versa as well.
- When gold prices do poorly, then other investments tend to do well. For instance, over the two decades from 1980 through the year 2000 the price of bullion dropped from a high of $850 an ounce down to less than $300. Meanwhile, the S&P 500 index rallied more than 1000%, not including dividends, according to data from Yahoo Finance. That more than a 10-fold increase.
- Gold is still useful to own during times of market stress. That's true even though we aren't there now. During the 2008-2009 financial crisis, there were periods when certain securities couldn't be sold. An example of that is the market for auction rate auction rate securities, a type of bond. If you owned those notes during that period, then you couldn't sell them no matter how low a price you offered. However, the market for gold never dried up. There were always ready buyers for the metal or the futures. It should be evident that currently, the securities markets are not stressed. Stocks are booming, and investors are happily trading bonds.
- The fact that gold prices move up and down is one of its attractions for investors. Just like other investments, the price of gold changes from day to day. However, those price movements don't tend to correlate with the changes in the value of stocks or bonds. When share prices drop then gold prices might move up down or remain unchanged. That lack of correlation helps to diversify a portfolio. Better still, when looked at in combination with other investments, adding gold can reduce a portfolio's overall volatility. For investors, risk and volatility are the same thing. Lower volatility is tantamount to lower risk.
All these points remain true despite Friday's pullback. If you own gold and are worried that prices may drop then think about why you purchased it in the first place. Most veteran investors say that they own it for one of the following three reasons: To help with portfolio diversification, or as a hedge against the declining value of paper money, or as insurance that you'll always be able to raise cash by selling some of the metal.
Simon Constable | Author | Broadcaster | Journalist | Commentator | Speaker. I'm a fellow at the Johns Hopkins Institute for Applied Economics, Global Health and the Study of Business Enterprise. My first book, The WSJ Guide to the 50 Economic Indicators that Really Matter, which I coauthored with Robert E. Wright, was an economics category winner in the 2012 Small Business Book Awards at Small Business Trends. It has sold over 80,000 copies in multiple languages.