Why Is Gold Crushing the Stock Market This Year?

gold Canadian liberty dollar coins

Earlier this month, the stock market celebrated the fifth anniversary of its current bull run, with major stock-market indexes having posted unusually strong gains of 25 to 35 percent in 2013. So far in 2014, though, the S&P 500 (^GSPC) and other benchmarks have struggled to make any progress, while much stronger returns have come from an unexpected corner of the financial markets: gold.

With gains of about 15 percent so far this year, gold has surprised most people. But investors are more interested in whether the gains are sustainable -- and whether gold can continue to outshine stocks in the future.

Where Gold Has Been

Until 2013, gold put together one of the most impressive bull-market runs for any asset class in history, with 12 straight years of gains from 2001 to 2012. Moreover, gold's gains put the stock market's returns to shame.

Certainly, stocks have produced strong returns for investors over the past five years, with the Dow Jones Industrials (^DJI) having risen 150 percent since March 2009's lows. But as impressive as that performance has been, it's weak compared to the more than 500 percent gain for gold over that 12-year stretch.

Last year, though, gold came crashing down to earth, ending its winning streak with a 28 percent plunge. Many investors blamed the Federal Reserve for the plunge, pointing to its deliberations early in 2013 on the best way to ease off its economic stimulus measures. By December, the Fed had turned that talk into action, trimming its monthly bond purchases gradually to keep long-term interest rates down. By signaling its belief that the economy could continue to strengthen without further extraordinary measures, the Fed undercut fears that inflation would skyrocket due to the huge amount of money the central bank had injected into the financial system. The downward pressure on the U.S. dollar from extraordinarily low interest rates also eased off, hurting gold.

Is Gold Back?

So far in 2014, several events have helped support gold prices.

One was simply that after such a huge decline in the price of gold in 2013, bargain-hunting gold investors started coming into the market to buy. Even last year, lower gold prices stimulated greater demand for jewelry and gold bars and coins, with the World Gold Council reporting that consumer demand for gold worldwide hit new record levels of 3,864 metric tons. China alone bought more than 1,000 metric tons of gold for jewelry, bars, and coins, and several other countries posted new records for gold demand as a result of cheaper prices.

In addition, economic trends around the world have been less encouraging, helping drive safe-haven buying of gold. In the U.S., a tough winter has had a measurable impact on the overall economy, with retailers seeing less customer traffic and manufacturers therefore having less demand for the goods they make. Meanwhile, signs of a potential economic slowdown in China have raised concerns around the world.

Finally, geopolitical tensions have put gold in a brighter light, with the current conflict between Ukraine and Russia having huge potential to drive further price gains. Russia is the world's fourth-largest producer of gold, with roughly 5,000 metric tons of known gold reserves and production of more than 200 metric tons in 2012 . If the U.S. and other Western countries impose economic sanctions on Russia, the impact on the gold market could be huge, both in terms of supply and demand, and from the ramifications of such restrictions on financial markets generally.

All That Glitters

As gold investors found out in 2013, gold can be volatile in both directions. Yet even though gold has already outpaced the stock market in the first few months of 2014, gold prices could keep rising if the conditions that have taken hold so far this year stay in place in the months to come.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.​

Originally published