Are gold and oil effective hedging tools for investors?

KEY TAKEAWAYS

• Gold and oil are frequently viewed as a hedge against geopolitical tension but have diverged sharply in performance this year amid heightened geopolitical uncertainty.
• Gold appears to have better supply-demand dynamics than oil and has been benefitting from concerns about the path of U.S. debt and deficits, regardless of the election outcome.
• Generally speaking, commodities have been uncorrelated to U.S. stocks, bonds, and real estate. As a result, they may help reduce risk in a broad, diversified portfolio.

Gold and oil have been on the upswing lately amid heighted geopolitical tensions in the Middle East. But oil remains well off its 52-week high and has experienced choppy performance this year — underperforming energy stocks and badly lagging gold, which hit record highs and is 2024’s best performing major asset class year to date.¹ We examine the divergence between these oft-discussed assets and the role commodities can play in a diversified portfolio.

Asset performance – year to date

Source: LSESG Datastream, chart by BlackRock Investment Institute, as of 10/3/2024. The bars show the total return in local currency terms, except for currencies, gold, and copper which are spot returns. Government bonds are 10-year benchmark issues. Euro and Yen are shown as strength vs. U.S. dollar. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Chart description: Bar chart showing the year-to-date performance of major financial assets as of Oct. 30, 2024, among which gold is the best performer with an over 30% return.

WHAT’S BEHIND GOLD’S RECORD RISE?

Gold is historically lauded as a haven during economic turmoil, often viewed as a hedge against both inflation and volatility shocks alike. Under the hood, gold’s record as an inflation safeguard has proved mixed — after generating standout returns in the 1970s as oil shocks drove U.S. inflation up, its performance as a hedge faltered more recently. Notably, spot gold prices were rangebound in 2021 while inflation surged and, conversely, gold has risen sharply in 2024 as inflation notably decelerated.²
More accurately, gold has tended to trade in closer relationship to real rates and the U.S. dollar³, which has fallen in the past six months as traders anticipated the Fed’s transition to an easing cycle, which began on September 18.⁴
Gold’s recent price appreciation also hails from two additional catalysts: central bank demand to diversify reserve holdings, adding over 2,000 tons in the past two years , as well as concerns over U.S. budget deficits.
With government spending unlikely to slow regardless of the election’s outcome and U.S. debt already breaching new highs each month, there’s reason to believe gold may have further price appreciation ahead.
Somewhat surprisingly, gold’s year-to-date price gains have yet to generate strong interest from retail investors, judging by flows in precious metal exchange traded products (ETPs). But that may be starting to shift — after spending most of 2024 in arrears, flows for the year are now close to breakeven thanks to strong inflows over the past month.⁵

WHERE’S THE ENERGY IN OIL TRADING?

A year rife with heightened geopolitical tensions — particularly the recent escalation of tension between Iran and Israel — would seemingly be an ideal backdrop for crude as well. The relationship between oil markets and geopolitical uncertainty is not a new development. International conflict often leads to fragmentation of highly complicated supply chains, sanctions on exports (translating to dampened supply), and the risk of contagion to key oil-producing regions. As a result, in times of heightened tensions, portfolio managers may hedge geopolitical risks via long-energy trades.
A Fed easing cycle plus China’s recent stimulus announcement would seemingly add further fuel to the proverbial fire. But despite experiencing occasional sharp jumps in price action amid concerns over developments in the Gulf, oil has been rangebound; both Brent Crude, the global benchmark and West Texas Intermediate are marginally higher year-to-date and remain well off their respective April peaks.
Fundamentally, the bottom line for crude — any commodity really — comes down to supply and demand, which does not currently favor bullish bets on oil. In October, the Organization of the Petroleum Exporting Countries (OPEC) reduced its forecast  for the third-straight month for oil demand for both 2024 and 2025 while maintaining its supply outlook for both time periods.⁶
Less demand plus higher (or stable) supply is not a recipe for a sustained move up in oil prices. Our base case is for oil prices to remain rangebound, absent attacks on energy production in the Middle East or a prolonged and pronounced rebound in China’s economic activity following recent stimulus announcements by the People’s Bank of China.
It’s worth noting the energy sector’s performance is typically fueled by more than the movement of oil prices. For example, we see the energy sector having the largest earnings deceleration⁷, a potential near-term drag as quarterly reporting season kicks off. While the energy sector has historically been an outperformer in the 12 months following a presidential election, as detailed in part 2 of our election playbook, we see potential headwinds ahead and maintain a neutral tactical outlook.

GOLD AND OIL: HISTORICAL PATTERNS AND THE RELATIONSHIP TODAY

With gold’s record rise and oil’s struggles in 2024, it’s likely a good time to examine the gold to oil ratio (i.e. how many barrels of oil that one ounce of gold can purchase through history). This ratio is a fascinating relationship, that may serve to help investors determine whether gold or oil are under- or overpriced relative to one another and may provide clues as to where their relative prices are heading on a forward-looking basis.
The gold to oil ratio is currently sitting at around 39 barrels of oil per one ounce of gold, more than double its long run average of approximately 18.⁸ If the relationship returns to historical averages, this could imply that gold is overpriced relative to oil — and that oil is underpriced relative to gold. With significant tailwinds potentially supporting the price of both gold and oil, even if prices for both commodities rise, their long run historical relationship may imply that gold has less room to move higher than oil.

WHAT ROLE DO COMMODITIES PLAY IN A PORTFOLIO?

Commodities are raw materials that are either consumed directly or used as building blocks to create other products. Investing in commodities can provide diversification benefits within a portfolio and may also serve as a hedge against inflation, geopolitics, or both.
Over the last 10 years broad commodities exhibited low (and occasionally negative) correlations to U.S. bonds, real estate and stocks.⁹ As such, small allocations to commodities may potentially help diversify and reduce risk within traditional investment portfolios.  iShares offers a wide range of commodity ETFs and ETPs across three categories: broad commodity, physical precious metals, and commodity producers ETFs.

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Originally Posted November 1, 2024 – Are gold and oil effective hedging tools for investors?

¹ Source: BlackRock Investment Institute as of Oct. 3, 2024. Past performance does not guarantee future results.
² Source: Bloomberg for gold price. Inflation measured by Consumer Price Index.
³ Source: Bloomberg, BlackRock. Correlations as represented by 120-day rolling correlations over a 10-year period, data as represented by daily closing price from Bloomberg. Correlation measures how two securities move in relation to each other. Correlation ranges between +1 and -1. A correlation of +1 indicates returns move in tandem, -1 indicates returns move in opposite directions, and 0 indicates no correlation. As of October 1, 2024.
⁴ Source: Bloomberg. Dollar represented by DXY as of October 15, 2024.
⁵ Source: Bloomberg. As of September 15, 2024.
⁶ Source: OPEC: Monthly Oil Market Report.
⁷ Source: Reuters, FactSet, BlackRock. Energy sector as represented by MSCI Global Industry Classification Standard (GICS). As of October 1, 2024.
⁸ Source: Bloomberg, BlackRock Calculation as of 9/30/2024. The data indicate the month end gold price in USD per troy ounce and month-end crude oil price per barrel in USD from January 1951 to September 2024.
⁹ Source: Morningstar Direct as of 10/1/2024 using Monthly Index Returns data. Bonds represented by the Bloomberg US Aggregate Bond Index, Real Estate represented by the Dow Jones US Real Estate Capped Index, Stocks represented by the S&P 500, Commodities represented by the S&P GSCI Index.

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Following an investment in shares of the Trust, several factors may have the effect of causing a decline in the prices of gold and a corresponding decline in the price of the shares. Among them: (i) Large sales by the official sector. A significant portion of the aggregate world gold holdings is owned by governments, central banks and related institutions. If one or more of these institutions decides to sell in amounts large enough to cause a decline in world gold prices, the price of the shares will be adversely affected. (ii) A significant increase in gold hedging activity by gold producers. Should there be an increase in the level of hedge activity of gold producing companies, it could cause a decline in world gold prices, adversely affecting the price of the shares. (iii) A significant change in the attitude of speculators and investors towards gold. Should the speculative community take a negative view towards gold, it could cause a decline in world gold prices, negatively impacting the price of the shares.
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