Gold as Strategic Asset

Importance of Gold as a Strategic Asset
Gold – the easiest investment for complex times

Stocks, bonds and alternative assets are enriched by gold of well-balanced US investor portfolios. Gold, as a store of wealth has surpassed many major asset classes and always providing vigorous performance in rising as well as in falling markets.

A portfolio can be enlarged by Gold by:
1. achieving long-term returns
2. acting as an effective diversifier and reducing losses in times of market stress
3. serving liquidity with no credit risk
4. elaborating overall portfolio performance

New challenges:
Not only has gold a huge role in portfolios but it is also more and more relevant in our current environment and investors need to face challenges around asset management and portfolio construction. There are various gold investment options and you need to choose the best to suit your needs like:
1. Physical Gold
2. Gold-backed ETFs
3. Allocated Gold Accounts
4. Internet Investment Gold
5. Gold Mining Stocks

Gold is more and more recognised as a mainstream investment as global investment demand has grown by an average of 14% per year since 2001 and the gold price has increased by almost six-fold over the same period.

Reasons for the Growth:
1. The development of growing market and economic expansion, especially in China and India have changed and increased the base of the investors and gold consumers.
2. Central Bank’s growing interest in gold worldwide has inspired investors to see gold as a positive investment aspect.
3. Fiscal Policy with continuous low interest rates lead to less opportunity cost of holding gold and highlight its attributes as source of genuine, long-term returns.
4. Market access: Gold-backed ETFs in 2003 made the access to the gold market possible and boosted the interest in gold as a strategic investment, lowered ownership cost and increased efficiencies.
5. Market Risk: Gold has become a traditional hedge for investors in times of economical and political crisis focusing on effective risk management and gratitude of uncorrupted highly liquid assets such as gold.

Source of returns:
In periods of uncertainty Gold is a beneficial asset with bringing long-term positive The price of gold has increased by an average of 10% per year since 1971 when the gold standard collapsed. Over this period, gold’s long-term return was comparable to stocks and higher than bonds. Gold has also outperformed other major asset classes over the past two decades.

Gold assessment:
Valuation frameworks used for stocks or bonds are not common for gold. Without a coupon or dividend, typical discounted cash flow models fail and there are no expected earnings or book-to-value ratios either. Valuing gold is intuitive where its equilibrium price is determined by the intersection of demand and supply which we highlight with Qaurum.
Gold’s performance depends on economic expansion, risk and uncertainty, opportunity cost and momentum.


Beating inflation, combating deflation:
Gold is a hedge against inflation and also protects investors against extreme inflation. In years when inflation was higher than 3% gold’s price increased 15% on average. Over the long term, therefore, gold has not just preserved capital but helped it grow. Oxford Economics shows that gold should do well in periods of deflation. Such periods are characterised by low interest rates, reduced consumption and investment, and financial stress, all of which tend to foster demand for gold.

Outperforming fiat currencies:
Investor demand has been boosted by persistently low interest rates and concerns about the outlook for the dollar, as these factors affect the perceived opportunity cost of holding gold. Historically, major currencies were pegged to gold. That changed with the collapse of Bretton Woods in 1971. Since then, gold has significantly outperformed all major currencies as a means of exchange. This outperformance was particularly marked immediately after the end of the Gold Standard and, subsequently, when major economies defaulted. A key factor behind this robust performance is that the supply growth of gold has changed little over time – increasing by approximately 1.6% per year over the past 20 years. By contrast, fiat money can be printed in unlimited quantities to support monetary policy, as exemplified by the Quantitative Easing (QE) measures in the aftermath of the global financial crisis.

Diversification:
The benefits of diversification are widely acknowledged—but effective diversifiers are hard to find. Many assets are increasingly correlated as market uncertainty rises and volatility is more pronounced, driven in part by risk-on/risk-off investment decisions. As a result, many so-called diversifiers fail to protect portfolios when investors need them most. Gold is different, in that its negative correlation to stocks and other risk assets increases as these assets sell off. The 2008-2009 financial crisis is a case in point. Stocks and other risk assets tumbled in value, as did hedge funds, real estate and most commodities, which were long deemed portfolio diversifiers. For example, the S&P 500 fell by 50% from December 2007 to February 2009. Gold by contrast held its own, rising 14% over the same period.
Gold has consistently benefited from “flight-to-quality” inflows during periods of heightened risk. It is particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses. Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, undervalued and possibly mispriced. But gold’s correlation does not just work for investors during periods of turmoil. It can also deliver positive correlation with stocks and other risk assets in positive markets. This dual benefit arises from gold’s dual nature: as an investment and a luxury good. As such, the long-term price of gold is supported by income growth.

Deep/liquid market:
The gold market is large, global and highly liquid. Physical gold holdings by investors and central banks are estimated worth approximately US$3.7tn, with an additional US$900bn in open interest through derivatives traded on exchanges or the over-the-counter market. The scale and depth of the market mean that it can comfortably accommodate large, buy-and-hold institutional investors. In stark contrast to many financial markets, gold’s liquidity does not dry up, even at times of acute financial stress.

Portfolio performance:
Long-term returns, liquidity and effective diversification all benefit overall portfolio performance. In combination, they suggest that a portfolio’s risk-adjusted returns can be materially enhanced through the addition of gold. Our analysis of investment performance over the past 5, 10 and 20 years underlines gold’s positive impact on an investor portfolio. For example, an average US investment portfolio would have achieved higher risk-adjusted returns if 2.5%, 5% or 10% of the portfolio were allocated to gold over the past decade. The positive impact has been particularly marked since the global financial crisis.
In addition to historical back-testing, a more comprehensive optimisation analysis based on New Frontier Advisors Resampled Efficiency shows that US dollar-based investors can benefit from a material enhancement in performance if they allocate between 2% and 10% of a well-diversified portfolio to gold. The amount of gold varies according to individual asset allocation decisions. Broadly speaking however, 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.
Gold versus commodities:
Gold is often considered part of the broad commodity complex, whether as a component of a commodity index (e.g. S&P GSCI Index, Bloomberg Commodity Index), a security in an ETF or a future trading on a commodity exchange. Gold shares some similarities with commodities.

Differences between Gold and commodities:
- Gold is a traditional safe-haven asset, highly liquid and offers effective downside portfolio protection during difficult times.
- Gold is an investment and a luxury good, which reduces its correlation to other assets
- Gold supply is balanced, deep and broad, limiting uncertainty and volatility
- Gold does not degrade over time like other commodities

Conclusion:
Over the past 2 decades the image of gold has changed considerably following increased wealth and a growing recognition of the role of the Gold within the investment portfolios around the globe.
Gold’s unique aspects as a rare, highly liquid and uncorrupted asset prove that it can act as a genuine diversifier over the long term. Gold’s position as an investment and a luxury good has allowed it to deliver average returns of approximately 10% for nearly 5 decades, comparable to stocks and more than bonds and commodities. Gold’s traditional role as a safe-haven asset means it comes into its own during times of high risk. But gold’s dual appeal as an investment and a consumer good means it can generate positive returns in good times too. This dynamic is likely to continue, reflecting the current environment of high political and economic uncertainty, historically low interest rates and concerns surrounding stock and bond markets.

For further information please contact us through our website www.liemeta.com.cy