Financial journalists often call gold a 'safe haven'. This rare, indestructible asset shines for headline writers when risks grow for other assets, and talk of inflation, trade wars or military action repeatedly see gold cast as an answer to investor anxiety. But does the metal really offer to offset losses across a diversified portfolio? 
Gold's physicality certainly sets it apart from most mainstream financial assets. Against the credit and settlement risks inherent in debt instruments and equities, gold bullion is nobody's promise and no-one's to default on. But while an investor in other 'alternatives' can at least drink their fine wine or watch their woodland grow, physical gold does nothing. It doesn't even rust.
In fact, while more people than ever before now carry a little gold in their pocket thanks to the boom in smartphones, only 10 per cent of annual end-demand now comes from industrial applications such as bonding wire, medicine or dentistry. Jewellery consumers account for the lion's share (55 per cent over the last five years), with solid and relatively inelastic demand worldwide by weight. Investment is the most variable element, growing and falling in opposition to the broader economic climate.
For any individual investor, buying a lot of gold suggests a bet on very bad things happening. As a Bank of England officer briefs 007 in the film Goldfinger, "Fear, Mr Bond, takes gold out of circulation and hoards it against the evil day." But by the same token, buying a little gold suggests more of an insurance policy – a defence or hedge, just in case other things fail to perform. Aiming to diversify an already broad portfolio further, one large trust client of BullionVault today holds a little over 1 per cent of its financial assets in gold. Among our retail-investor clients, a 5-10 per cent weighting is more typical, again with the aim of smoothing returns by spreading risk.
This is how central banks have also come to use gold since the classical Gold Standard ended. As a group, central-bank reserve managers have bought nearly one ounce in every five mined over the last 100 years. According to a senior Banque de France manager, the appeal comes first from gold's security: the absence of any credit risk is an intrinsic quality. Second, gold is uniquely liquid, both because of its daily depth (volumes settled through London, heart of the global bullion market, are comparable to the largest currency pairs outside the G5) and because volume tends to increase during political or investment turmoil. Together, these create the third motivation for holding gold: diversification.
Across the last half-century, gold has tended to do well when other assets didn't, and it performed best – ironically – when people lost faith in central banks, whether over their ability to control inflation or stem financial crisis. Of course, this dynamic means gold has tended to fall during extended bull runs in the stock market. So where owning nothing but gold proved very smart during the 1970s, it proved very costly during the Long Boom which followed.
Here in May 2018, and even after falling by one-fifth in price from the peak of 2011, gold remains the best-performing major asset class for UK portfolios so far this century. Gold priced in Sterling has on average risen 7.5 per cent faster than the cost of living since the end of 1999. That compares with total real annual compound returns of 2.8 per cent, per year from UK shares and 4.2 per cent from long-dated gilts.
Shorter horizons also show gold acting to offset poor performance in other assets. Priced in Sterling, gold has gained in seven of the nine years since 1971 that the FTSE All-Share index lost value on a total returns basis. That includes all five years that saw equity values fall by double-digits, with gold averaging a near-40 per cent annual gain.
Why might gold prices move in opposition to equities? Part of the reason is because, unlike other financial assets, gold finds a huge range of users outside profit-seeking investors, from those central-bank reserve managers (now led by Russia, Turkey and China) to Hindu temple-goers in India, Valentine's day shoppers in Hong Kong, and micro-chip fabricators in the US and Japan.
The metal's relative uselessness to industry also counts, because it means gold is less exposed to the economic cycle – a fact which separates it from other precious metals like silver and platinum. Finally, the idea of gold as a 'safe haven' during times of financial stress means that investors can and do bid it higher when other assets fall. You may see this as simply a tradition, with no logical basis. But like gold's broader appeal as a store of value, this tradition has endured across all ages and in all cultures of human history. Even dismissed as a fad, demand from other investors is what drives gold's value for diversifying a portfolio when it matters most.
On BullionVault's analysis, a 10 per cent holding in a simple portfolio otherwise split 60:40 between UK shares and long-dated gilts would have cut the drawdown in 2008 (the worst single year for UK assets) from 13.1 per cent to 7.6 per cent, and it would have boosted annualised returns in 2000-2004 (the worst 5-year period) from 1.0 per cent to 1.4 per cent. As with any insurance there has been a "premium" to pay, and CAGR (compound annual growth rate) over the last four decades would have slipped from 11.5 per cent to 11.2 per cent. Over the last 20 years however a 10 per cent gold holding would have boosted overall returns, taking the CAGR from 7.1 per cent to 7.4 per cent as equities and real yields struggled while gold shone.
If gold has and could again reduce portfolio losses when other assets fall, might gold-mining shares prove better still? Mining fund managers often speak of the "leverage" to bullion prices which gold producers' fixed costs should create. The sector has also been growing its output, with global mine production setting a fresh record in 2017. But while capital expenditure has been recovering with bullion prices in the last two years, so too have production costs, and the industry needs much higher margins to pay down its debt and start paying dividends.
Moreover, mining shares bring exactly those management, credit and equity risks which physical bullion lacks. Q1 2018 saw gold-mining funds deliver three of the five worst performances among all UK funds according to data from FE Analytics, losing between 12-15 per cent against a 2 per cent drop in the sterling price of gold itself.
If you want more equity risk, buy equities. If you want to diversify, it's worth considering the rare, useless lump of metal which other investors have repeatedly bid higher during equity bear markets.
Adrian Ash is director of research at BullionVault. All views are his own and should not be taken as investment advice.