This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Gold has underperformed the US stock market over the long term. However, the yellow stuff has a reputation for being a safe haven asset amid times of uncertainty. And many have even referred to gold as an inflation hedge.
For part of 2020 to 2022, the inflation hedge story rang true as gold passed $2,000 per ounce for the first time in history in 2020 and then reached an all-time high of $2,074.60 per ounce in March 2022.
But in the last four months, gold suffered an 18% drawdown from that high -- meaning that gold is nearly in a bear market during a time when it should be holding its value. In this vein, gold seems to be failing as an inflation hedge. And in fact, there is data to suggest that gold's reputation as an inflation hedge has been largely exaggerated, even by historical measures.
Here's what's pressuring gold now -- and why it may be a good buying opportunity despite not being an effective inflation hedge.
1. A strong US dollar
A slowdown in economic growth and rising geopolitical issues tend to help the price of gold. However, a strong US dollar hurts the price of gold, because a strong US dollar relative to other currencies makes it more expensive for foreign buyers to purchase US dollar-denominated gold.
The US Dollar Index, which tracks the value of the dollar relative to the value of the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona, is at a 20-year high. Part of the ascent is due to the US Federal Reserve rapidly raising interest rates to combat inflation. High interest rates encourage foreign investment in US Treasury bonds. High interest rates also mean that holding gold has an opportunity cost, given it doesn't pay interest like a US certificate of deposit.
In past US recessions, the Federal Reserve would lower interest rates and hopefully weaken the US dollar in an effort to encourage domestic consumption and make it less expensive to export US goods. However, because the Federal Reserve's priority No. 1 is lowering inflation, not preventing a recession, the dollar could remain strong for the foreseeable future. A strong dollar is arguably the biggest headwind holding gold back right now.
Gold Price in US Dollars data by YCharts
2. The rise of digital gold
Over the last few years, there have been several polls that suggest millennials and Gen Z are more likely to view cryptocurrency as a preferred investment than gold. Granted, many of those polls were taken before the recent crypto crash. However, millennials are now the most active generation in the economy given that many Baby Boomers have retired. Less demand for gold as an investment in risk-averse or retirement portfolios could dampen demand.
3. Compelling alternatives
Many investors may feel that beaten-down stocks are a better buy now than gold. They are probably right. Gold may be down 18% from its high, but there are plenty of top stocks that are down well over 50%. Even several well-known Dow Jones Industrial Average components, such as Nike, Home Depot, and Salesforce are all down between 30% and 53% from their all-time highs.
Legendary investorWarren Buffett has long said that gold is a bad investment because its growth prospects are limited to supply and demand, rather than a company that can grow with innovation and good management. By keeping cash on the sidelines or buying gold now, an investor essentially says investing in gold is a better use of capital than a different asset.
Why gold may be a good buy now
Despite all the cons discussed, now could be the perfect time to add a bit of gold to a diversified portfolio, especially if that portfolio is in need of lower-risk assets. Aside from the drawdown in price, gold could be the ideal investment for a prolonged recession, ongoing economic weakness, and could even rebound if the US dollar begins to weaken.
The Federal Reserve has made it clear that it is raising interest rates to combat inflation but that the rises would likely stop once inflation is in check. If unemployment rises, the job market weakens, and the US falls into a recession, inflation would likely ease due to lower consumer spending. That's a terrible setup for most assets, but a decent one for gold.
While it may be tempting to buy shares in a gold mining stock that is down even more from its high, the simplest and safest way to buy gold is to go with an exchange-traded fund (ETF) such as the SPDR Gold Shares (NYSEMKT: GLD) ETF or the iShares Gold Trust (NYSEMKT: IAU). Both of these ETFs are at 52-week lows and are meant to track the price of gold by holding insured physical gold in a trust. The SPDR Gold Shares ETF has an expense ratio of just 0.4%, and the iShares Gold Trust offers an even lower 0.25% expense ratio -- which is a much better and more liquid alternative than buying physical gold bars and paying a hefty premium above spot.
For investors looking for low-risk assets to buy now, opening a starter position in a gold ETF could be a reasonable move to make.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
