Beyond the glitter: Why gold remains a strategic asset in today's market

Gold has enjoyed an enduring appeal, used for millennia as a store of value and a hedge against currency debasement and uncertainty. In recent years, mounting government deficits, persistent inflationary pressures, and escalating geopolitical tensions have helped spur gold demand, pushing prices to record highs.

With global markets confronting an array of risks, the glitter of gold is hard to ignore.

However, investors should dig deeper than gold’s performance. The asset class demands a nuanced understanding of its notorious volatility, current valuation, and role in portfolio construction.

Structural tailwinds

Gold’s history in the modern era has been punctuated by dramatic booms and busts, leading some investors to wonder if the metal’s torrid rally is at risk of running dry.

Perhaps. However, structural forces are working in its favor.

Central bank activity has often served as a contrarian indicator for gold prices, epitomized by the Bank of England’s sale of gold reserves from 1999–2002 that effectively marked the bottom of the market before prices embarked on a generational ascent.

Russia’s invasion of Ukraine has changed this dynamic.

At the outset of the war, Western governments acted quickly in freezing Russia’s foreign exchange assets and restricted its access to the dollar-based financial system. In turn, some central banks sought to reduce their dependency on developed market sovereigns by increasing their gold reserves and diversifying away from the U.S. dollar.

• Since 2022, central banks have accumulated over 1,000 tons of gold annually—more than twice the average over the previous decade.¹
• Gold’s share of central bank reserves has climbed to 20%, making it the world’s second-largest reserve asset behind the U.S. dollar, which has seen its share decline to 46%.²

This structural demand shift is unlikely to reverse soon, which could provide a continued tailwind for gold prices amid limited new supply. That said, investors should focus less on chasing price action and more on gold’s strategic role in portfolio construction.

Inflation: Transitory no more?

Whether gold qualifies as a traditional diversifier is a matter of debate. Skeptics point to its high volatility, lackluster returns over longer periods, and lack of yield. Nevertheless, gold can provide downside mitigation from inflation shocks, as it famously did in the 1970s and in the aftermath of the coronavirus pandemic.

A key question for investors is whether global price pressures are temporary or a sign of structurally higher inflation.

U.S. fiscal policy remains expansionary, with Washington struggling to rein in deficits. China is ramping up stimulus efforts. Japan is experiencing wage pressures after decades of deflation. And Europe is boosting both defense and infrastructure spending.

These developments, alongside a move toward deglobalization and supply chain reshoring, suggest that inflationary pressures may be here to stay.

Improving fundamentals in mining stocks

For investors looking to gain exposure to gold, some options include physical bars or coins, gold-backed exchange-traded funds (ETFs), mining stocks, and royalty companies.³ Each comes with its own set of potential advantages and trade-offs.

• Physical gold is widely considered to be a form of tangible security, but it is a less liquid way to gain exposure to gold and comes with storage and insurance costs.
• Gold-backed ETFs generally provide liquidity and ease of access, but they may lack the tangibility that some investors seek. Additionally, they may not perfectly track the price of gold due to market dynamics and other factors.
• Mining stocks, on the other hand, offer operating leverage to gold prices—but their exposure to gold is indirect, and they come with idiosyncratic risks.

Historically, operational missteps and poor capital allocation have stifled the potential of gold miners. This has led many investors to instead favor royalty companies, which often focus on sustaining profit margins and reinvesting capital into new streaming and royalty contracts, offering a more stable investment model.

“A key question for investors is whether global price pressures are temporary or a sign of structurally higher inflation.”

Recently, however, gold miners have shown greater discipline. The benefits of higher gold prices are beginning to reflect in their earnings, with only nominal cost inflation and significant free cash flow. Equity markets have been slow to price in these improvements, suggesting skepticism about the sustainability of the mining industry’s current economics. 

This creates an opportunity for active managers. However, a high gold price environment doesn’t benefit all mining companies equally, and stock selection is critical. Miners with disciplined capital allocation, as well as smaller emerging producers and royalty companies, look to be best positioned for the current environment.

The bottom line

In a world of constant flux, gold isn’t just a shiny relic. It can be a strategic asset and a compelling component of a diversified multi-asset portfolio, offering the potential to reduce the sting of inflation shocks and improve resilience during turbulent times.