Black swan events have ushered in an almost forgotten economic era of inflation and policy rates higher than 2% for the first time in over a decade, writes John Reade, market strategist Emea for World Gold Council.
After years of easy returns in equity markets, and with bond yields so far struggling to catch up with inflation, investors and money managers are increasingly paying attention to alternatives to find new sources of returns.
This makes sense, but while fashionable alternatives investments make the headlines, there is a case to be made for gold, the longest-standing alternative investment asset.
Aside from returns, gold’s most valuable characteristic is as a portfolio diversifier. Normally uncorrelated to equities, gold tends to become negatively correlated to equities – and assets with equity-like returns – when equities fall fast.
This change in correlation is unique amongst asset classes, and makes gold a far more effective portfolio hedge than other asset classes, government bonds or commodity indices, for example. Having an appropriate amount of gold in a portfolio would have increased the risk-adjusted return of that portfolio over the past 5, 10 or 20 years and would have dramatically reduced drawdowns too.
As well as returns and portfolio diversification, gold’s position as an asset that is no-bodies liability is also extremely valuable. Central banks, which have been net buyers of gold every year since the global financial crisis, know this.
The World Gold Council’s latest Gold Demand Trends report confirms that central bank purchasing was at record levels in H1 23 and there is little evidence that their interest is waning. It may come as no surprise that gold has indeed achieved better returns than most assets over the first half of this year and continued demand in this sector is likely to support the price in most near-term scenarios, but with upside potential if unexpected events occur.
Liquidity is another critical component in changeable markets and gold can provide the answer here. In the current market – and historically – there are ready buyers for gold in almost all scenarios. Part of this is due to the diverse, global gold market which means it is almost uniquely liquid.
What drives price and demand amongst the institutional or official sector today differs from the motives of, for example, jewellery buyers. While these factors may seem a distant consideration for an investor considering gold, it is vitally important for those with an eye on both price stability and the ability to exit or adjust positions to suit changing needs.
The current state of the market is an excellent illustration of gold’s highly liquid quality. Central banks in both developed and developing markets have been a major driver of gold demand for the past decade. The resultant high prices are less attractive for the large but price-sensitive jewellery markets in Asia, with the most prominent of those being India and China. Should the demand amongst large investors decline and prices fall, demand picks up elsewhere.
The self-balancing characteristics of the global gold market are unusual and allow for the fact that, as one segment of the market buys less – or even turns a net seller – others have historically always picked up the slack. This reduces the volatility of gold and provides support to the market under most circumstances. It has also been critical in driving the performance of gold in the most challenging market conditions.
Other alternative investment options certainly have merit in a diversified portfolio but liquidity, or a lack of it, is a well-documented problem. Even real estate investment, which is traditionally popular amongst non-traditional investments has had its fair share of problems, with investors gated in funds that have suffered severe devaluation on multiple occasions in the past decade. Liquid alternatives are still risky assets, but they are almost entirely immune from even short-term lock-ins.
Central bank demand for gold has also bolstered the performance and has shown that, despite some misconceptions, the metal is a driver of long-term returns, too. The price of gold has almost doubled over the past decade and it has done so stably and relatively uncorrelated to other assets.
This is a rare combination of characteristics that alone are attractive for most client portfolios, but is not an either-or choice between gold and traditional assets that provide the comfort of company balance sheets or investor income streams. Instead, it should be considered in the context of risk and return in the face of markets that are hard to predict.
Alternatives present a solution, but the true value of advice now will be on the individual characteristics of the wide range of alternatives on offer. The liquid, stable nature of a gold market that can provide long and short-term returns where other assets cannot is a compelling proposition indeed.
This article was written for International Adviser by John Reade, market strategist Emea for World Gold Council.