Thinking About How Gold Could Be Part of Your Portfolio?

Gold seems to be everywhere these days. While we are used to seeing gold piling up in central bank vaults, being fashioned into jewellery or handed out at athletic events, more recently, you can even pick up bars alongside milk and eggs at Costco. The precious metal has also been a longtime staple in many investors’ portfolios.

There’s a reason interest in gold has been growing. Prices have climbed by nearly 40 per cent¹ over the past two years– you can buy one ounce for about $2,300 USD at the time of writing. One factor that has contributed to the increase is unease over the global economy. High inflation and geopolitical turmoil tend to be key drivers for the price of gold, and these challenges have been hard to ignore in recent years. What may be surprising about the gains in gold is that they’re happening at a time when the U.S. dollar remains strong. Usually, gold is inversely correlated with the greenback²; meaning when one goes up the other goes down, although this trend has been known to breakdown for short periods from time to time.

Gold has typically been viewed as a hedge against economic challenges, especially inflation, because of concern that interest earned on savings won’t keep up with the rising cost of living, explains Jeffrey Schok, a Senior Portfolio Manager with RBC Global Asset Management who oversees the RBC Global Precious Metals Fund. Historically, gold has increased in value in inflationary periods because, unlike government-backed currencies which are not supported by a physical commodity, there is a limited supply of gold, which means it can’t get diluted the way paper money can. “People who’ve invested in gold over long periods of time have generally been able to maintain their purchasing power,” he says.

Another reason for the rising price of gold is that global central banks have been adding to their stockpiles in recent years. Many countries hold their foreign reserves in U.S. dollars but worries over how sanctions or economic disputes could affect the value of their local currencies have caused some countries to diversify their reserves beyond the U.S. dollar. “Central banks around the world have realized how potentially insecure and fragile their reserves are,” says Schok.

For example, according to the World Gold Council³, China has ramped up its gold purchases, which now make up about 4.6 per cent of that country’s total reserves as of the first quarter of 2024, up from 3.9 per cent for the same period a year earlier. That’s a significant increase in demand for gold considering the size of the Chinese economy, explains Schok. Asian consumers have also been buying into the rally, fuelling demand even more.

Ways to Invest

Although half of the demand for gold comes from jewellery, the price is partly driven by market sentiment and the fact that it’s widely considered to be a valuable asset. With a commodity like silver, which is used in electronics, solar technology and medicines, there is a greater influence on supply and demand from industrial uses that can affect prices. With gold, if investors think there may be an economic downturn, they may be more likely to buy to preserve their wealth, but when the clouds part, they may think about selling, which can drive down the price⁴.

There are a few different ways to gain exposure to gold. Some of the options are buying physical gold coins or bars, buying direct shares in the mining companies that produce the metal, and investing in ETFs or mutual funds that have a gold component. Even within the public markets, there are a range of investment options that behave differently and serve different objectives. For instance, some exploration companies are, as Schok puts it, “always potentially one drill hole away from making a massive discovery,” but these are often much riskier businesses to hold. If they don’t hit the jackpot, their stock could plummet. Other developers are advancing projects like ones that have historically proven to be successful, likely with the goal of selling to a larger, more established producer that has the capital and experience to operate a mine.

You can also buy shares in royalty companies or streamers. These businesses have contracts with gold producers that allow them to buy a portion of their production, typically at a fixed price, says Schok.

There are also a range of exchange-traded funds (ETFs) or mutual funds that give you access to this part of the market, and may help you diversify your portfolio with exposure to multiple companies. Some ETFs and mutual funds invest in a mix of different gold and mining companies, while others may target one part of the sector. There are also ETFs that hold physical gold. And if you already own an ETF or index fund that mirrors the S&P/TSX Composite, for example, then you already have some exposure to gold in your portfolio, given metals and mining stocks – including several gold companies – account for about 12 per cent of the index⁵. There are some risks associated with both holding physical gold and stock in gold-mining companies, Schok notes. For instance, when you hold physical gold, you may have to take on additional costs for insurance and storage costs. Selling physical gold may not be as easy as selling stocks, and some resellers may offer prices below market value.

On the other hand, gold mining companies may outperform physical gold. As Schok explains, in theory, if a gold company has fixed operating costs and borrows money to expand their operations, then it could boost profitability rising the company more quickly than the value of the underlying commodity. However, if the price of gold falls, it could lower the value of the company.

Do Your Research

If you decide to invest in individual gold companies, there are four main points Schok likes to consider before buying. He looks at the quality and location of the assets, the track record of the management team, the company’s valuation, and the company’s environmental, social and governance (ESG) characteristics.

The last point is key, he explains. Mines that don’t have strong environmental and social policies often fail to gain ‘social license’, and may encounter community issues such as protests or blockades. It is also possible that an accident which damages the environment could result in the suspension of the mine’s operating permit. “In the end, they just fail,” he says of companies that don’t have strong ESG policies. “It hurts their operations, which in turn negatively impacts their share price and makes it more difficult for them to raise money.”

Adding Gold to Your Portfolio

While some retail stores are capitalizing on the gold frenzy by marketing gold bars to consumers, Schok says gold stocks potentially could outperform with the rising price of bullion. Both approaches have their risks and merits. If you want to add gold to your portfolio, you could also explore a more diversified approach, with a mix of physical gold and gold stocks – including miners, explorers, producers and royalty companies – either directly or through a fund. Whether you see the current market as a gold rush or a way to protect your wealth, before you invest make sure you do your research and take time to ensure your decision aligns with your risk profile.

¹ _{Source: Google Finance, Gold Continuous Contract quote, July 2024}
² _{Source: Macrotrends, "Gold Prices and U.S. Dollar Correlation - 10 Year Chart"}
³ _{Source: World Gold Council, "Gold Demand Trends Q1 2024", 30 April, 2024}
⁴ _{Source: Economics Observatory, "Is gold a safe haven for investors?", 26 February, 2024}
⁵ _{Source: TMX Info Services, S&P/TSX Composite Index}