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+.​

The Most Useful Things the World Does With Gold
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Why Is Gold Crushing the Stock Market This Year?

When most people think of gold, they usually think of jewelery, or coins and bars -- the metal as a hard investment. Today, though, gold is used in host of technological and industrial applications.

Article by Paul Ausick

Jewelry still accounts for the biggest share of demand for the precious metal. In the second quarter of 2011, jewelery makers purchased nearly half of the total gold demand of 920 metric tons, according to the World Gold Council's latest Gold Demand Trends report. Demand from investors accounted for 39% of the total. Only 13%, or 118 metric tons, went for technological and industrial uses.

The precious metal's unusual chemical and physical qualities make it a highly desirable material for use in six specific industries, according to the the World Gold Council: electronics, nanotechnology, automotive, space, engineering, and medicine. Some of the uses are fairly mature: dental fillings, for example. Other uses in engineering and nanotechnology are still in their early days.

Of the 118 metric tons used last year industrially, 84 metric tons went to electronics and 11 metric tons to dentistry. Of the remaining 23 metric tons, most of the gold was likely used in electroplating, as the other technology applications use minute amounts and many are not even available commercially.

Gold's current high prices are no doubt curbing a more widespread use of the metal as an industrial commodity. While miners and investors might not mind the steep rise in price, industrial users and consumers will either search for substitutes or delay buying.

The world today is full of electronic circuit boards, from computers to cellphones. Because gold is a highly efficient conductor, it's used to make the bonding wires that connect those circuit boards' components -- and there are thousands of connections on a single circuit board. But because those bonding wires are thinner than a human hair, the total amount of gold used is minuscule. A mobile device like a smartphone or tablet PC contains about 0.0002 ounces of gold. At $1,800 an ounce for gold, that's only 36¢ worth of gold in a typical device. Of course, with 1 billion phones manufactured each year, demand for gold from that industry alone adds up to 91 metric tons of gold -- $360 million worth. More will be accounted for by the 400 million desktops and laptops, and the more than 250 million TVs that will be manufactured in 2011 alone.

For centuries, gold has been used to make stained glass -- and not just golden-hued glass, either. When it's broken down into  nano-sized particles -- we're talking billionths of a meter -- the precious metal stops being gold colored and reflects a deep crimson red or a light blue. Nanoparticle gold also has a wide variety of other uses --  especially as a chemical catalyst. Using gold as a catalyst in making paints and adhesives could lead to the elimination of toxic mercury from the process. In chemical processes, a gold catalyst can lower both the temperature and pressure needed to start a reaction, thereby reducing the amount of fuel needed -- and thus the cost of production.

Using gold leaf as a decorative element on buildings has a long history: The Egyptians were the first to figure out how to stretch a single ounce of gold into a thin sheet that could cover 200 square feet. Today, even thinner films of gold are used as a reflective coatings on windows to keep buildings cooler. It's now possible to stretch an ounce of gold to cover up to 1,000 square feet of window surface. Similarly, a gold-palladium alloy is used to braze metals subjected to very high operating temperatures, like jet engines. A thin plating of gold is also used on some parts of fuel cells to reduce corrosion and increase electrical conductivity.

Catalytic converters have used precious metals for years to remove harmful emissions from car and truck exhausts. Platinum and palladium are the most popular, but the recent addition of gold to catalytic converters used on diesel-powered vehicles opens up a new use for the metal. These gold-added converters are coming into widespread use in Europe, where engines have to meet the world's most stringent emission requirements. When the technology was introduced in 2008, gold was cheaper than platinum or palladium, making those catalytic converters at the time cheaper than those using other precious metals. For the moment, this is no longer the case.

Gold's attributes of high reflectivity, electrical conductivity and corrosion resistance have made it a mainstay of space programs. In the U.S., the now-defunct space shuttle program used about 90 pounds of gold in each shuttle -- about $2.4 million worth at today's prices. Putting gold into space may be the equivalent of sending coal to Newcastle: Recent research indicates that the Earth's gold may have come from a massive meteor shower that hit the planet 4 billion years ago. And there's plenty more where that came from. The single asteroid Eros contains more gold than has ever been mined on Earth.

Because of its resistance to tarnishing and decay, gold has been used in medicine for thousands of years. Ayurveda practitioners in India today are estimated to consume a few metric tons of gold every year. In the seventh century BCE, the Etruscans used fine gold wire to fasten false teeth. Modern dentistry continues to demand gold -- 11 metric tons of it in the second quarter of 2011 alone. Nanoparticles of gold serve many other modern medical uses -- in pregnancy test kits, in treatments for rheumatoid arthritis and certain cancerous tumors, to detect quickly the presence of food-borne pathogens like salmonella and E. coli, and to provide rapid screening tests for HIV.

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