Both a store of wealth and a multi-faceted hedge, gold has outperformed many major asset classes amid recent volatility
At the start of a new decade – and what could be a new era for portfolios – investors are increasingly turning to gold in pursuit of diversification and risk-adjusted returns. That’s according to research from the World Gold Council, which has found that adding between 2 and 10 per cent in gold to a hypothetical average UK investment portfolio over the past decade would have resulted in higher risk-adjusted returns.
Demand for gold has grown by 14 per cent per year since 2001, and its price has increased by almost six-fold over the same period, the World Gold Council reports. There are a number of reasons for this shift. Emerging market growth – a core trend of the past decade – has increased and diversified gold’s consumer and investor base, something that has been bolstered further by the launch of gold-backed ETFs in 2003, which reduced the cost of ownership.
After the start of the financial crisis 12 years ago, investors’ newly intensified focus on risk management led to a renewed appreciation of uncorrelated returns, leading to gold’s re-emergence as a traditional hedge in times of turmoil. It’s a position that has been re-affirmed by a background of persistently low interest rates, reducing the opportunity cost of holding the asset class. Central banks have also encouraged other investors to consider the ‘positive investment attributes’ of the precious metal.
Gold’s average annual return of 12 per cent over the past 49 years has outpaced the UK Consumer Price Index, and its status as a protector against inflation is affirmed by its track record of rallying in periods of devaluation: In years when inflation was above three per cent, gold price’s increased by an average of 13 per cent. Gold has also ‘significantly outperformed’ all major fiat currencies since the end of the gold standard in 1971.
Finding the right mix matters
In an investment climate where diversification is imperative, effective tools are hard to come by. Many assets track spikes in volatility driven further by risk-on/risk-off investment decisions.
Gold stands apart from this popular trend. Its negative correlation to stocks and other risk assets increases as these other assets are subject to sell-offs. For instance, between December 2007 and February 2009, the FTSE 100 fell by 41 per cent, while gold increased in price by 60 per cent over the same period.
Gold has consistently benefited from ‘flight-to-quality’ inflows during periods of heightened risk, notes the World Gold Council. It is particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses, allowing investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, undervalued and possibly mispriced.
With an estimated £2.7 trillion in physical gold held by investors and central banks worldwide and an additional £700 billion in open interest, the gold market is sizeable, global and liquid.
Indeed, according to the World Gold Council, it is more liquid than several major financial markets. Gold’s trading volumes averaged £114 billion per day last year, a period during which over-the-counter spot and derivatives contracts accounted for £61 billion and gold futures traded £51 billion per day across various global exchanges. Gold-backed ETFs can provide an additional source of liquidity, with the largest US-listed funds trading an average of £1.5 billion per day.
The optimal amount of gold varies according to individual asset allocation decisions, the World Gold Council notes, but in a broad sense, the higher the risk in a 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.
According to its research, the ‘average’ UK portfolio would have achieved higher risk-adjusted returns if between 2.5-10 per cent of their portfolio were allocated to gold over the past decade, with its positive impact being ‘particularly marked’ since the last financial crisis.
As a result, the research notes that gold’s optimal weight in a hypothetical portfolio is ‘statistically significant’ – even if ‘investors assume an annual return for gold of between 2 and 4 per cent – well below its actual long-term historical performance’.
Going for gold
Extensive analysis from the World Gold Council suggests that adding between 2 per cent and 10 per cent of gold to a pound sterling-based portfolio will make a ‘tangible improvement’ to performance and boost risk-adjusted returns on a sustainable, long-term basis.
The wide variety of gold-backed and gold-related investment products provide many ways to get into gold for every type of investor. The most popular options are as follows:
- Physical Gold: Bars and coins come in many denominations and measures of gold content (also called fineness) and account for approximately two-thirds of annual investment gold demand over the past decade. Owning bullion is the simplest way of buying gold but owning physical gold may involve additional costs beyond the initial expense of the gold, including insurance and storage.
- Gold-backed ETFs and similar products: First launched in 2003, ETFs and similar products are backed with physical gold and allow investors to track the price of gold. They provide an easy way to access the benefits of physical gold ownership but without the need to arrange for storage and insurance separately.
- Allocated Gold Accounts: Bullion banks offer their high net worth or institutional customers allocated gold accounts consisting of gold deposits and resembling currency accounts where the investor is the holder of a specific quantity of gold. Unallocated accounts are also available where the investor does not own specific bars or coins but a general entitlement to a set amount of gold.
- Internet Investment Gold: An increasingly common way of accessing the gold market is Internet Investment Gold (IIG). Internet Investment Gold allows investors to buy physical gold online, have it stored in professional vaults and take possession of it should the need arise. This offering is seen as a highly convenient way for investors to benefit from outright ownership of physical gold.
- Gold Mining Stocks: Investors can also invest in shares of gold mining companies. Gold mining company stocks may correlate with the gold price. However, the growth and return in the stock depend on the expected future earnings of the company, not just on the value of gold.
Amid renewed uncertainty around markets in 2020, the status of gold as a clear complement to equities, bonds and broad-based UK investor portfolios has seldom been more important.
In the past two decades, the asset class has earned an appreciation within investment portfolios offering scarcity, liquidity and uncorrelated performance. These unique characteristics have solidified its place as a genuine long-term portfolio diversifier.
Gold’s position is unique, the World Gold Council notes. Not only is its traditional role as a safe haven particularly crucial in today’s market environment, but its value as an investment and luxury good means that it is able to generate positive returns throughout positive market environments too. Indeed, gold has delivered average returns of approximately 12 per cent for nearly five decades, comparable to stocks and more than bonds and commodities. If ever there was a time for investors to go for gold, it would be now.
Learn more about the case for gold for individual investors on Goldhub