Why own gold?

For thousands of years, gold has been seen as a store of value. It's a tangible asset with a finite supply, and it has several traditional roles that it can play in an investment portfolio.

• Diversifier: Gold often exhibits a low correlation to other assets like stocks and bonds. This means its price tends to move independently, which can help reduce the overall volatility of a portfolio.
  
  
• Safe-haven asset: During periods of significant economic crisis or geopolitical instability, investors often "flee to safety" by buying gold. It tends to hold its value when other assets are falling, acting as a potential portfolio shock absorber.
  
  
• Inflation hedge: Gold prices can sometimes (though not always) rise when the purchasing power of currencies like the US dollar falls.

What gold is not

While the roles above can be valuable, there is one critical fact all investors must understand: gold is a non-productive asset.

Unlike a stock, it does not pay a dividend, and unlike a bond, it does not pay interest. In other words, investors are not compensated for owning it and the only way to earn a return from gold is for its price to go up. 

Because of this lack of cash flow, the value of gold is not determined by fundamentals (like a company's profits or a bond's coupon payments). Instead, its price is driven purely by supply and demand—in short, by what people believe it is worth. This makes its value particularly susceptible to shifts in investor sentiment and highly volatile.

For this reason, gold should not be considered a growth asset. Its primary role in a portfolio should be defensive in nature (to hedge or diversify), rather than offensive—at least over the longer term.

The distraction of narratives

When an asset's price begins to soar, powerful market narratives inevitably emerge to explain the rally. Our colleagues at ATB Economics and Research, for example, have noted several factors that underpin gold’s recent rise, including rising global debt levels, a weaker US dollar, and sustained central bank purchases.

While these are grounded and valid economic factors, the conviction and strength of such narratives tend to amplify the longer the price continues to increase. This is a common feature of the markets—as humans, we naturally desire a compelling story to justify price movements. These stories often appeal to our emotions and increase the desire to participate in potential future gains.

This is precisely where long-term investors must exercise discipline. Remaining well-informed does not always equate with taking action and it’s important to not let headlines or compelling narratives over-influence your investment strategy. A stable strategy, built on a long-term plan, is our best defense against emotionally driven decisions that may not end up being in our best interests.

Considerations for investors

There is nothing inherently right or wrong about including gold in your portfolio. What is essential is maintaining clarity of purpose before making any investment. Without a clear strategic reason for owning it, you leave yourself vulnerable to market volatility and shifting headlines.

Here are a few things to consider:

1. Define your approach:
   
   1. Is it short-term or tactical? If so, your approach may fit the definition of speculation, which differs from long-term investing. It would be prudent to identify the precise factors driving your decision and establish clear, pre-determined selling parameters in order to minimize the risk of emotion-driven loss.
      
      
   2. Is it long-term or structural? If so, be prepared to tolerate gold’s potential for significant downturns and remain steadfast in your investing objectives. This means you’ll need a clear understanding of its exact role in your portfolio. Remember, as a diversifier, it fulfills its role best when it behaves differently than other assets—even if it underperforms while the rest of your investments are doing well.
      
      
2. Don't overdo it. Because gold doesn't pay you to hold it, owning too much can drag down your portfolio's long-term returns by taking the place of productive, income-generating assets. Additionally, due to its high volatility, a little can go a long way. For most investors, a small allocation (perhaps 5% to 10%) is more than enough.
   
   
3. You may already have exposure. Many Canadian investors may already have meaningful indirect exposure to gold prices without realizing it. The materials sector— which is dominated by gold mining companies that benefit when the price of gold rises—is the second-largest sector of the Canadian stock market (TSX Composite). If your portfolio includes Canadian stocks or managed funds, you likely already have a degree of exposure.
   
   
4. Focus on the "why," not the "when." Don't let headlines guide your investment strategy. The right time to consider gold isn't when everyone is talking about it, but during a calm, strategic review of your long-term goals and strategic asset allocation.

Consult with your financial advisor to confirm that your portfolio, and any existing exposure to gold, remains in lockstep with your ultimate financial goals.