As markets have continued to move into the latter stages of the cycle, investors might want to consider an investment in gold as a strategic asset, according to the World Gold Council.
Investment demand for gold has been growing by 15 per cent per annum since 2001, driven by the growth of exchange-traded products and the expansion of the middle classes in Asia.
However, there are four key reasons for holding gold in the current economic environment, according to the gold industry trade body.
These include: as a source of long-term returns; as a diversifier that can mitigate losses in times of market stress; as a liquid asset with no credit risk that has outperformed fiat currencies; and, as a means to enhance overall portfolio performance.
“Today, gold is more relevant than ever for investors,” said the World Gold Council. “While central banks in developed markets are moving to normalise monetary policies – leading to higher interest rates – we believe that investors may still feel the effects of quantitative easing and the prolonged period of low interest rates for years to come.
“These policies may have fundamentally altered what it means to manage portfolio risk and could extend the time needed to meet investment objectives.”
The trade body added: “Many investors are drawn to gold’s role as a diversifier – due to its low correlation to most mainstream assets – and as a hedge against systemic risk and strong stock market pullbacks.
“Some use it as a store of wealth and as an inflation and currency hedge. Particularly in the UK, gold has acted as a safe haven in times of market stress including periods of heightened uncertainty since the Brexit referendum.”
Below, the World Gold Council examines in further detail how the precious metal can be used as a strategic asset by UK investors.
Effective diversifiers are not easy to find, the World Gold Council noted, adding that correlations tend to increase as market uncertainty and volatility rises, “driven in part by risk-on/risk-off investment decisions”.
“Consequently, many so-called diversifiers fail to protect portfolios when investors need it most,” the trade body analysts said.
This was best seen during the global financial crisis of 2008 when alternative assets such as hedge funds, broad commodities and real estate sold off with other risk assets.
“This was not the case with gold,” the analysts noted, adding that the precious metal benefits from flight to quality during periods of heightened risks.
“The greater a downturn in stocks and other risk assets, the more negative gold's correlation to these assets becomes.”
“Gold has also allowed investors to meet liabilities while less liquid assets in their portfolio were undervalued and possibly mispriced.”
Its dual nature as a luxury good and as an investment means that fold long-term price trend is supported by income growth.
Indeed, this leads to another key role of the yellow metal: a source of long-term returns.
The World Gold Council noted that its price has increased by an average of 12 per cent per year – in sterling terms – since 1971.
The precious metal’s scarcity and its ability to trade in large and liquid markets have fuelled the gold prices over the long term.
Production has increased annually on average by just 1.4 per cent over the past 20 years, far below demand growth.
In addition, returns have also outpaced UK consumer price index (CPI) inflation over the long run.
“Gold has not just preserved capital; it has helped it grow,” the trade body noted. “In years when inflation has been higher than 3 per cent, gold’s price has increased by 12 per cent on average.”
The size and liquidity of the gold market is another key benefit for investors.
Trading at between £40bn and £60bn per day, a strategic holding within a portfolio offers a way to liquidate a gold position easily than some other assets.
For investors tempted to make a strategic allocation to cash, gold could offer a more attractive alternative.
The World Gold Council said gold has greatly outperformed all major currencies as a store of value over the past century. This is particularly notable when central banks have engaged in money printing exercise to support monetary policies.
Finally, all these factors combined can mean that adding gold to a portfolio can enhance risk-adjusted returns, the trade body noted.
The chart above shows risk-adjusted return defined as portfolio return divided by annualised volatility and based on the total return indices and benchmarks using data from December 2008 to December 2018. Rebalanced yearly, the composition of the hypothetical average portfolio is based on a survey conducted by Personal Investment Management and Financial Advice Association and includes a 53 per cent allocation to stocks (32 per cent FTSE 100, 21 per cent FTSE All-World ex UK), 32 per cent allocation to fixed income (22 per cent Bloomberg Barclays UK All Bonds index, 5 per cent Barclays Global Aggregate Corporate Bonds, 5 per cent Barclays GBP Cash), and 15 per cent alternative assets (15 per cent Hedge Fund Research Absolute Return index). Gold’s performance is based on the LBMA Gold price in sterling and the respective 2 per cent, 5 per cent and 10 per cent portfolio allocations come from proportionally reducing all assets.
“Over the past decade, UK investors with an asset allocation equivalent to an average private investor portfolio would have benefitted from including gold in their portfolio,” it noted. “Adding 2 per cent, 5 per cent or 10 per cent in gold would have resulted in higher risk-adjusted returns.
“But studying simulated past performance alone of a hypothetical average portfolio does not allow us to evaluate how much gold investors should add to a portfolio to achieve the maximum benefit.”
World Gold Council analysts said that for UK dollar-based investors, holding between 2 per cent to 10 per cent in gold as part of a well-diversified portfolio can improve performance even more.
“Broadly speaking, the higher the risk in the portfolio – whether in terms of volatility, illiquidity or concentration of assets – the larger the required allocation to gold, within the range in consideration, to offset that risk,” they said.
However, the World Gold Council further noted that such outcomes are also true for other inflation-hedging assets such as inflation-linked bonds.
As such, while gold is often lumped together with other commodities by investors, it may pay to take a closer look at differences of the metal compared with other natural resources.