Don’t give up your gold

Gold is not dead.

Just ask Germany.

Germany’s Bundesbank recently announced that it had completed the transfer of $13 billion in gold bullion that had been stored in vaults beneath Lower Manhattan, returning the metal back home. The country began repatriating its gold in 2013 with the aim of once again storing 50% of its reserves in Frankfurt.

When the gold transfer was complete, Germany would have removed all the gold it stored in Paris, leaving only 13% of its reserves in London and roughly a third of its reserves in New York.

With the rise of cryptocurrencies – such as Bitcoin – and digital cash such as PayPal, Apple Pay and other applications, there has been a steady decline in the use of physical cash, making the yellow metal feel downright archaic.

But gold has a special status, stronger than even the few twenties in your wallet right now. The precious metal offers a blanket of safety and security. It is considered more reliable than any government-issued currency.

Just look at the euro, a currency for a union of countries that threatens to break up. (Germany certainly feels better about having a golden home again.)

Or even the US dollar, a currency backed by some $20 trillion in debt.

Not only is gold alive and kicking, but it should play an important role in your portfolio…

Let me just start with this: I am not a gold bug.

I am a trader first and foremost and I usually have a short time frame as my target. I was brought up on the variety of options and fast trading for good profits. I don’t care if the market is bull, bear or – shudder to think – range bound. There is always a way to win if you know where to look.

But gold is a complicated thing.

It does not pay dividends, so there is an opportunity cost associated with the metal.

However, when there is market uncertainty, faltering economic growth or geopolitical controversy, gold shines as a safe haven in the storm. When stocks crash, investors will turn to gold as a safe way to store some of their greenbacks instead of simply converting them to cash and tucking them under their mattresses.

And given the way gold is trading, it seems that many investors are not too sure about this rally in the market.

The hedge

In 2016, the price of gold rose more than 8%, almost in step with the stock market, as the S&P 500 gained 9.5%.

In fact, the World Gold Council reported that gold demand rose 2% in 2016 to 4,309 tonnes, marking a new three-year high.

And less than two months into the new year, we have gold up another 8%, outpacing the S&P’s roughly 5% gain – which is remarkable.

When stocks are strong and investors believe in a market rally, they are happy to ditch gold for securities that promise much better returns.

For example, during the dot-com bubble, the S&P 500 rose from January 1995 to September 2000 by more than 200%. In contrast, gold stumbled 27% over the same time period.

Or look at the market rally from October 2012 to January 2016, when the S&P 500 gained 37% while the yellow metal crashed 35%.

In short, when times are good, gold is the forgotten child left in time-out until it learns to play nice with other assets.

And when times are bad, gold is the prodigal son, offering security and protection.

So if the stock market is trading at all-time highs and regularly setting new records, why does gold still shine as the favorite?

The financial market has its fair share of potential stumbling blocks that could bring everything down sharply. Let’s go through a quick list:

  • Stocks are overvalued. We recently explained that stocks are painfully overvalued by traditional measures and we are preparing for a reversion to the mean.

  • Washington in turmoil. Our new president has promised a series of extreme moves that could have significant consequences for both the US market and the global market, which could start with a sharp slowdown in earnings.

  • The next outlet in Europe. The EU and the UK are stumbling through Brexit, as well as major elections coming up – Italy, Germany, the Netherlands and France. Moreover, Europe’s growth has been largely ignored by many investors and could become the next hot trade as they tire of the drama in the US

  • The derivatives nightmare. The US is facing a meltdown that could rival the effects of the housing bust as America’s five biggest banks have piled up interest-rate-linked derivatives.

  • The Fed’s wild card. The latest minutes from the Federal Open Market Committee meeting revealed that the Federal Reserve is looking to raise interest rates “relatively soon.” Higher interest rates will suck money out of the economy as it costs more to service our growing debt. Higher interest rates also tend to dampen equity gains.

Investors are watching these issues closely, waiting for one or more of them to knock the stock off its current path.

Your disaster insurance

Of course, that doesn’t mean the market will fall off a cliff tomorrow.

I think the one quote that every speculator is fighting over is, “The market can stay irrational longer than you can stay solvent.”

In short, just because a stock or index has risen to all-time highs doesn’t mean it can’t keep going higher, even if it doesn’t make logical sense to you and me.

But it doesn’t hurt to have a hedge to protect yourself when it all goes down.

Gold remains that perfect hedge: your insurance against the Fed, Washington, reckless banks, Europe, and even that black swan that hasn’t hit our radar yet. That’s why gold still shines as a favorite even during this year’s stock market highs—investors know they need a safe haven, just in case.

Physical gold is your best option instead of investing in “paper gold” such as exchange-traded funds.

No matter how you choose to add physical gold to your portfolio, the important part is that it’s there, ready to be your safe haven when everything falls apart.