Gold - Strategic Asset

Gold has a key role as a strategic long-term investment and as a mainstay allocation in a well-diversified portfolio. Investors have been able to recognise much of gold’s value over time by maintaining a long-term allocation and taking advantage of its safe-haven status during periods of economic uncertainty. Gold is a highly liquid asset, which is no one’s liability, carries no credit risk, and is scarce, historically preserving its value over time. It also benefits from diverse sources of demand: as an investment, a reserve asset, gold jewellery, and a technology component. These attributes mean gold can enhance a portfolio in three key ways: Delivering long-term re-turns, improving diversification and providing liquidity. Combined, these characteristics make gold a clear complement to stocks and bonds and a welcome addition to broad based portfolios. More-over, the shift towards a greater integration of environmental, social and governance (ESG) objec-tives within investment strategies has important implications and we believe gold can play a role in supporting these. Gold should be recognised as an asset that is responsibly sourced and delivered from a supply chain that adheres to high ESG standards. Gold also has a potential role to play in reducing investor exposure to climate-related risks.

Effective diversifiers are sometimes hard to find. Many assets become increasingly correlated as market uncertainty rises and volatility is more pronounced, driven in part by risk-on/risk-off in-vestment 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 equities and other risk assets increases as these assets sell off. The GFC is a case in point. Equities and other risk assets tumbled in value, as did hedge funds, real estate, and most commodities, which were long deemed portfolio diversifiers. Gold, by contrast, held its own and increased in price, rising 21% in US dollars from December 2007 to February 2009. And in the most recent sharp equity market pullbacks of 2020 and 2022, gold’s performance remained positive.

This robust performance is not surprising. With few exceptions, gold has been particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses. But gold’s correlation does not just work for investors during periods of turmoil. It can also deliver pos-itive correlation with equities and other risk assets in positive markets, making gold a well-rounded efficient hedge.

This benefit arises from gold’s dual nature: as both, an investment and a consumer good. As such, the long-term performance of gold is supported by income growth. When equities rally strongly, their correlation to gold can increase. This is driven by a wealth-effect supporting gold consumer demand, as well as demand from investors seeking protection against higher inflation expectations.

The gold market is large, global, and highly liquid. We estimate that physical gold holdings by inves-tors and central banks are worth approximately US$4.8tn, with an additional US$1.0tn in open in-terest through derivatives traded on exchanges or the over-the-counter (OTC) market.The gold market is also more liquid than several major financial markets, including euro/yen and the Dow Jones Industrial Average, while trading volumes are similar to those of US 1–3-year treasuries and US T-Bills among primary dealers. Gold’s trading volumes averaged approximately US$132bn per day in 2022. During that period, OTC spot and derivatives contracts accounted for US$78bn and gold futures traded US$52bn per day across various global exchanges. Physically-backed gold ETFs (gold ETFs) offer an added source of liquidity, with global gold ETFs trading an average of US$2.3bn per day.

The scale and depth of the market means 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 financial stress. Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, or mispriced.

Long-term returns, liquidity and effective diversification all benefit overall portfolio performance. In combination, they suggest that the addition of gold can materially enhance a portfolio’s risk-adjusted returns.

While gold mining is, by definition, an extractive industry, responsible gold miners follow stringent frameworks to mitigate environmental impact and reduce risks. In fact, the social and economic contribution of the gold mining industry plays a key role in the communities and host countries in which it operates. It does so through the payment of wages and taxes, supporting local economic development, improving infrastructure, and providing access to healthcare and schooling, and much more. The majority of this expenditure remains in the local economies of host nations and communities, as documented recently in our measurement of the social and economic contribu-tion of gold mining. The industry is also committed to contributing to the advancement of the UN Sustainable Development Goals.

In addition, gold also has a potential role to play in reducing investor exposure to climate-related risks. In fact, gold’s lack of downstream emissions has important implications, as gold holdings can reduce the overall carbon intensity of the portfolio value. And the positive outlook for future de-carbonisation of the gold value chain has potential benefits for the projected carbon profile, ‘im-plied temperature’ and climate target alignment of portfolio holdings

Gold has the potential to perform better than many mainstream asset classes under various long-term climate scenarios, particularly if climate impacts create or exacerbate market volatility or we experience a disruptive transition to a net zero carbon economy. Furthermore, gold’s value is less likely to be negatively impacted by a rising carbon price, also offering investors a degree of insula-tion from the likely policy responses needed to accelerate the move to a decarbonised economy.

Given the risk/reward trade off associated with any investment, it is important to acknowledge and understand not only opportunities, but also key risks.

Non-standard valuation: Gold does not directly conform to the most common valuation method-ologies used for equities or bonds. Without a coupon or dividend, typical models based on dis-counted cash flows, expected earnings, or book-to-value ratios struggle to provide an appropriate assessment for gold’s underlying value.

No cash flows: A well-documented perceived drawback of gold is that it does not provide any regu-lar income whereas other asset classes, such as bonds, property or even equities, generate cou-pons, dividends and rents. This means that for investors to profit from gold, its price must in-crease. But in an era when other defensive assets like government bonds are providing low yield-to-maturities compared to history, gold’s zero yield has not been a major disadvantage.

Price volatility: Gold is a great diversifier to a portfolio because it behaves so differently to equities and bonds, not because it has a low volatility. And while gold is a less volatile asset than some eq-uity indices, other commodities or alternatives, in some years the metal has posted close to 30% gains (2010) and in other years it has posted close to 30% losses (2013). On balance however gold has an asymmetric correlation profile with equities; in other words, it does much better when eq-uities fall than it does badly when equities rise.

Perceptions of gold have changed substantially over the past two decades, reflecting increased wealth in the East and a growing worldwide appreciation of gold’s role within an institutional in-vestment portfolio. Gold’s unique attributes as a scarce, highly liquid, and uncorrelated asset ena-ble it to act as a diversifier over the long term. Gold’s position as an investment and a luxury good has allowed it to deliver annualised returns of nearly 8% since 1971, comparable to equities 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 its 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, reflect-ing ongoing political and economic uncertainty, and economic concerns surrounding equity and bond markets.