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“Gold has not just preserved capital, but has helped capital grow”
By Ivanka Pittelkau
Physical gold is a safe-haven asset, with no credit risk and no counterparty risk, and a solid investment now to allocate part of your portfolio as a hedge against other investment assets and against risks resulting from political activities, the market, fiat, and the banking sector. The fear of a global recession crawling in, national protectionist policies being created and current trade wars, have been pushing the price of gold upwards, above USD 1,400 an ounce, over the last few weeks.
During the 2013 banking crisis in Cyprus, gold would have provided security and a peace of mind provided that gold had not been stored in that specific bank, but instead stored with a sophisticated private physical storage company on a segregated basis and allocated in the name of the client.
Investing in Physical Gold
Gold is often bought as a luxury good in the form of jewellery emphasising its physical value. On the other hand, gold is often used as an investment. Of course, one does not rule out the other and society is generally more aware of gold as jewellery than an addition to one’s investment portfolio.
The contemporary gold market, despite its historical role as money, is quite young and only developed following the Nixon-era in 1971 when the gold standard was abandoned, and gold delinked from the USD. Since then, a global market for gold as an asset in its own right has developed, trading freely and remaining open around the clock. Only four markets are of global significance – the London, US, Switzerland and Hong Kong markets.
Physical bullions are mainly traded in London, the world’s largest gold market and where the LBMA (London Bullion Market Association) Gold Price is set, the world’s benchmark for pricing gold. Second in size is the US, dominating gold contracts (futures and options) and derivatives, also called “paper gold”, which too has a major influence on the price of gold. Switzerland and Liechtenstein have assumed the role of the world’s leading gold storage and world gold hub for physical bullions. Four of the world’s major refineries are located in Switzerland and two thirds of the globally mined gold physically transits through the country. Hong Kong is the principal marketplace for Asian investors, where both physical and paper gold is traded.
In future, we may even see a fifth influential gold market developing, namely that of China. China is today one of the largest producers and consumer nation for gold and with a strong appetite to play a more influential role in gold trading and pricing through the Shanghai Gold Exchange.
The gold market is, interestingly, one of the largest and most liquid boasting a turnover of over USD 240 billion daily which is more than all but four currency pairs and nearly equivalent to the daily dollar volume of trade on all the world’s stock exchanges combined.
Gold’s Long-Term Performance
Gold is value. Historically, dating back as far as 2500 years, gold has been used as a form of money (gold coins). Today, it is mainly used as a store of wealth.
Since 1971, the price of gold has increased by approximately 10% year-on-year. Investors who have held gold over the last 15 to 40 years may have had slightly lower overall returns on the long-term (when compared to the stock market depending on the time invested).
Average annual return of key global assets in US dollars*
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council
*As of 31 December 2018. Computations in US dollars of total return indices for ICE 3-month Treasury, Bloomberg Barclays US Bond Aggregate, MSCI US, EAFE and EM indices, Bloomberg Commodity Index and spot for LBMA Gold Price PM. For compounded annual growth rates see Appendix II.
Over this period, gold has outperformed all major fiat currencies and in USD terms has gained 416.44% in value over the last 20 years.
Relative value between major currencies and gold since 1900*
Sources: Bloomberg, Harold Marcuse – UC Santa Barbara, World Gold Council
*As of 31 December 2018. Based on the annual average price of a currency relative to the gold price.
**The ‘Mark’ was the currency of the late German Empire. It was originally known as the Goldmark and backed by gold until 1914. It was known as the Papermark thereafter.
This is attributable to the fact that it is rare and finite and cannot be printed in unlimited quantities (vs. cash) in support of monetary policies. Gold is a strikingly unique asset that is highly liquid and unlike other commodities it is not used, since it is hoarded as a monetary asset. The gold price is partly based on sentiment rather than being influenced by mine production and industrial demand, given the huge quantities of gold stored above ground compared to the annual production. Nearly all gold ever produced is still being held in some form or another and mining adds only about 1% to the total supply each year, which explains its value based on scarcity.
Over the long-term, the value and price of gold is supported by income growth. In the short- and medium-term, its price tends to rise during periods of uncertainty. This is due to gold’s dual nature as both a consumer good and as investment asset.
Gold Today
Gold is becoming ever more widespread as an investment asset. Since the turn of the century, global gold investment demand has grown by 18%. Central banks in the emerging markets (especially Russia and China) have collectively tripled their gold holdings over the past decade in order to reduce their dependence on the USD. In 2018 alone, 651.5 mt of gold were bought by central banks, which is 74% more than in 2017 and the highest level since 1971. Not to forget the increased number of individuals, as well as pension and sovereign wealth funds both in developed and emerging markets. The increase in this investor appetite is further attributable to an expanding middle class in Asia which has increased the purchasing power in that region.
The financial crisis of 2008-2009 played a vital role in the significance of gold. During and following the crisis, gold witnessed a 150% gain in its value when burnt investors flocked to a safe haven. On the contrary, stocks crashed. Gold moves anti-cyclical to other key asset classes and therefore proves itself during economic malaise and market stress, a situation that the markets are seemingly in again today.
Gold Price Chart 12 Years
Data as of 25 July, 2019
Sources: FastMarkets, ICE Benchmark Administration, Thomson Reuters, World Gold Council
It is therefore plausible that a small allocation in gold should constitute part of an investment to offset the unfavourable returns.
Diversification That Works
It is not the standalone performance of gold that works; it is the synergy of a range of assets that can reduce the portfolio risk and thus the cost of uncertainty. Gold is used to preserve wealth by enhancing overall asset performance. It acts like an investment insurance, smoothing risk and return and reducing overall losses when stocks, bonds or real estate fall sharply. Gold therefore plays a fundamental role in any investment portfolio.
Whilst often wealth preservation only becomes important during times of turmoil, this is naturally hard to predict. Industry veterans therefore suggest that it is a good idea to have a small allocation of your portfolio in gold. UBS recommends 7-15%, for example.
