Time to Trim, But Not Abandon Gold

For a year in which risky assets continue to grind higher, assets offering potential hedges against those risks are doing remarkably well. Long-duration U.S. bonds are up roughly 9% while gold has advanced better than 11%. The latter’s performance is particularly surprising.

Gold is up in an environment in which investors have had little reason to hedge; any market pullback has been both mild and fleeting. Yet gold has kept pace with the overall returns of a typical 60/40 portfolio. In other words, this has been an unusual year in that your hedges have not cost you anything in the form of foregone returns.

That said, I would be inclined to hold a bit less gold into year’s end and early 2018. My message: Trim, but don’t abandon, the asset class. Here’s why.

1. Washington

Back in late August I discussed the relationship between gold, political uncertainty and tax reform. While still not a sure thing, the odds of tax reform have risen since late summer. Fiscal stimulus in the form of a tax cut would arguably undermine gold in two ways: marginally higher real, or inflation-adjusted, interest rates, and less political uncertainty. As discussed in previous blogs, the best predictor of gold’s performance is the level of real rates. Marginally faster growth, even if only modest and temporary, is likely to put some upward pressure on real rates and correspondingly downward pressure on gold.

2. The U.S. dollar

One reason gold has done as well as it has year-to-date is weakness in the dollar. The U.S. Dollar (DXY) Index is down more than 9% from its early January high. More recently, however, the dollar has been firmer as investors have repositioned for a slightly more aggressive Federal Reserve (see the accompanying chart). In the near term I would expect a steadier dollar, particularly if the proposed tax cuts pass. A firm dollar removes another support for gold.

U.S. Dollar Index (DXY)

chart-dollar-index

Where does this leave investors? Still holding gold, just a bit less. For most investors, this means somewhere in the mid to single digits, as a percentage of their asset allocation.

But it’s important to note, while the near-term environment for gold is not ideal, there are still good reasons to maintain some exposure, including the diversification benefits. With the exception of long-dated U.S. bonds, gold continues to be one of the more diversifying asset classes.

In most instances of higher volatility, gold provides a hedge against not only equity risk but credit as well. With credit spreads tight (i.e. a sign that bonds are expensive) and U.S. equity valuations still stretched, investors may consider lightening up on their portfolio insurance, but they should not abandon it.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

More from BlackRock:

A rates disconnect that may not last

Why reflation has room to run

Where we see investing opportunities now

Investing involves risks, including possible loss of principal. Investments in natural resources can be significantly affected by the events in the commodities markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Site Editand BlackRock have or may have had an advertising relationship, either directly or indirectly. This post is not paid for or sponsored by BlackRock, and is separate from any advertising partnership that may exist between the companies. The views reflected within are solely those of BlackRock and their Authors.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.