Gold as a Strategic Asset
The World Gold Council explain it in depth in his papers and most analysts emphasizes gold’s unique position as a strategic, long-term asset in investment portfolios. Gold’s lack of credit risk, liquidity, and historical ability to preserve value through economic cycles underpin its role as a hedge and diversifier. Gold’s diverse sources of demand (investment, reserve asset, jewelry, and technology) ensure resilience across economic environments.
Key Benefits:
- Long-term returns during both economic booms and recessions.
- Diversification, reducing overall portfolio volatility.
- Liquidity, even during periods of market stress.
- Alignment with ESG goals, enhancing its relevance in modern portfolios.
Gold’s Key Attributes
- Long-Term Source of Returns
Gold has demonstrated consistent long-term performance. From the collapse of the US gold standard in 1971, its price in USD has risen by 8% annually—comparable to equities and superior to bonds.
Dual demand dynamics: During recessions, gold thrives on counter-cyclical investment demand, and during economic expansions, it benefits from pro-cyclical consumer demand.
The Gold Long Term Expected Return (GLTER) model links gold’s returns to global GDP growth, showing its ability to deliver returns above inflation.
2. Hedge Against Inflation and Deflation, QE
- Gold historically outpaces inflation, particularly during periods of high inflation (>5%), with returns averaging 8%-13% per year.
- During deflation, characterized by low interest rates and economic stress, gold’s safe-haven appeal strengthens.
3. Store of Value
Gold has consistently outperformed fiat currencies since 1971, thanks to its limited supply growth (~1.7% annually) and immunity to monetary policy interventions like QE.
Gold as a Portfolio Diversifier
Gold stands out as a highly effective diversifier due to its asymmetric correlation profile. It shows:
- Negative correlation with equities during market downturns.
- Positive correlation with equities during market recoveries due to wealth effects driving consumer demand for gold.
Case Studies:
- During the Global Financial Crisis (2007-2009), gold prices rose by 21% while equities plunged.
- Gold also delivered positive returns during recent sharp equity sell-offs in 2020 and 2022.
A Deep and Liquid Market
The gold market is global and highly liquid, with daily trading volumes averaging $227 billion in 2024. This is comparable to US Treasury Bills and exceeds many major financial markets, including equities and currencies.
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- Gold’s liquidity ensures it remains a reliable asset, even during financial stress.
- Gold-backed ETFs, futures, and OTC transactions significantly contribute to its market depth.
Portfolio Impact
- Risk/Reward Profile
A World Gold Council analysis of investment performance over the past 3, 5, 10 and 20 years emphasises gold’s positive impact on an institutional hypothetical portfolio made up by 50% stocks, 40% fixed income and 10% alternatives.
Including gold in a portfolio improves risk-adjusted returns while reducing volatility and drawdowns. A 5% allocation to gold in a portfolio over the past 20 years:
- Increased annualized returns from 6.3% to 6.4%.
- Reduced volatility from 9.9% to 9.6%.
- Reduced maximum drawdowns from -35.3% to -33%.
Increased risk-adjusted return from 63.3%to 66.9%.
The ‘optimal’ amount of gold varies according to individual asset allocation decisions. Broadly speaking, the analysis suggests that the higher the risk in the portfolio – whether in terms of volatility or concentration of assets – the larger the required allocation to gold, within the range in consideration to offset that risk.
- ESG Contributions
Gold’s ESG credentials position it as a sustainable asset:
- Gold mining companies follow stringent environmental and social standards, contributing to local economies, infrastructure, healthcare, and education.
- Gold holdings can reduce portfolio carbon intensity, offering insulation from climate-related risks and potential policy changes.
Potential Risks and Challenges
- No Cash Flows: Unlike bonds or dividend stocks, gold does not provide regular income. Investors rely on price appreciation, which has historically been consistent.
- Price Volatility: While gold’s volatility is lower than equities and other commodities, it can experience significant yearly fluctuations (e.g., +30% in 2010 and -30% in 2013). However, gold performs better when equities decline than it underperforms when equities rally.
Conclusion
The perception of gold has evolved significantly in the last two decades due to:
- Rising global wealth, particularly in the East.
- Growing recognition of gold’s strategic role in institutional portfolios.
Gold’s scarcity, liquidity, and low correlation make it a cornerstone of portfolio diversification. Its dual role as a luxury good and investment ensures strong performance across economic environments. As investors increasingly prioritize ESG goals, gold’s sustainable production and ability to mitigate climate-related risks further enhance its appeal.
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