For decades, gold has been treated by many investors as an eccentric investment, something to buy if you fear inflation, financial crisis or the end of the world. But the evidence increasingly points to a much simpler conclusion: gold should be a permanent part of a diversified investment portfolio.
Gold has played this role before. Since the US dollar broke its link with gold in 1971, gold has experienced three major bull markets: 1971–80, 1999–2011 and the current advance, which began in 2018. Different events drove each cycle, but the common ingredients are familiar: loose monetary policy, falling real interest rates, fiscal stress and declining confidence in paper currencies.
That last point matters today.
Modern currencies are fiat currencies. Unlike under the old gold standard, dollars, pounds and euros are not backed by a fixed quantity of gold. Governments and central banks therefore have enormous flexibility to create money and run deficits. That flexibility can be useful during crises, but over long periods it also creates an obvious risk, the purchasing power of money can be steadily diluted.
Gold is fundamentally different. It cannot be printed, and unlike a bond or bank deposit, it is nobody else’s liability.
Interestingly, central banks themselves are increasingly acting on this logic. Gold purchases by central banks have surged in recent years. One important catalyst was the freezing of Russia’s foreign exchange reserves in 2022. It demonstrated that even supposedly safe government bonds can become inaccessible. Gold held domestically carries no equivalent counterparty risk.
Central-bank demand, concerns about government debt and demand for assets outside the traditional dollar-based financial system are becoming increasingly important drivers of gold demand and the long-term trend for the gold price.
Gold also solves a portfolio problem for investors. The classic diversified portfolio combines equities with bonds because bonds are expected to perform when equities struggle. But during the inflationary shocks of recent years, stocks and bonds have repeatedly fallen together (2022 was the last example of this). Gold has often provided better diversification precisely because its drivers are different.
Despite this, investors globally still hold only a small proportion of their financial assets in gold. Allocations of 5% to 10% are considered as unusually aggressive. But the current trend and historic evidence suggests such an allocation is actually a very good idea for investors.
Gold does not generate profits like a company or pay interest like a bond. Nor should investors expect it to outperform equities indefinitely. That misses the purpose of owning it.
Equities provide long-term compounding growth. Bonds provide income. Cash provides liquidity. Gold provides something different, it offers protection against inflation, currency debasement, fiscal stress and failures in traditional diversification.
Investors insure their homes without expecting them to burn down. A strategic gold allocation works on a similar principle.
A permanent 5% to 10% allocation to gold should no longer look radical to investors, it should be considered a core foundation upon which the rest of your portfolio is built.
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