The relevance of gold as a strategic asset
Gold benefits from diverse sources of demand: as an investment, a reserve asset, a luxury good and a technology component. It is highly liquid, no one’s liability, carries no credit risk, and is scarce, historically preserving its value over time.
Gold can enhance a portfolio in four key ways:
- generate long-term returns
- act as a diversifier and mitigate losses in times of market stress
- provide liquidity with no credit risk
- improve overall portfolio performance.
"Our analysis illustrates that adding between 2% and 10% in gold to
a hypothetical US pension fund average portfolio over the past decade
would have resulted in higher risk-adjusted returns.1"
Focus 1: Understanding gold valuation
Gold does not conform to most of the common valuation frameworks used for stocks or bonds. Without a coupon or dividend, typical discounted cash flow models fail. And there are no expected earnings or book-to-value ratios either.
Our research shows that, in fact, valuing gold is intuitive: its equilibrium price is determined by the intersection of demand and supply which we highlight with QaurumSM.8
- Economic expansion: periods of growth are very supportive of jewellery, technology and long-term savings
- Risk and uncertainty: market downturns often boost investment demand for gold as a safe haven
- Opportunity cost: the price of competing assets, especially bonds (through interest rates) and currencies, influence investor attitudes towards gold
- Momentum: capital flows, positioning and price trends can ignite or dampen gold's performance.
New decade, renewed challenges
As the new decade begins, investors face an expanding list of challenges around asset management and portfolio construction. Among these:
- Low interest rates, which may push investors to seek riskier assets at elevated valuation levels and, for US pension funds in particular, may increase the value of liabilities, possibly reducing their funding ratio
- Continued financial market uncertainty ranging from geopolitical tensions, to expectations of diverging global economic growth and an increase in asset volatility.
We believe that gold is not only a useful long-term strategic component for portfolios, but one that is increasingly relevant in the current environment.
The increased relevance of gold
Institutional investors have embraced alternatives to traditional stocks and bonds in pursuit of diversification and higher risk-adjusted returns. The share of non-traditional assets among global pension funds increased from 7% in 1998 to 26% in 2018 – this is 30% in the US2.
Gold allocations have been recipients of this shift. It is increasingly 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.3
The principal factors behind this growth include:
- Emerging market growth: economic expansion – particularly in China and India – increased and diversified gold’s consumer and investor base
- Market access: the launch of gold-backed ETFs in 2003 facilitated access to the gold market and materially bolstered interest in gold as a strategic investment, reduced total cost of ownership and increased efficiencies
- Market risk: the global financial crisis prompted a renewed focus on effective risk management and an appreciation of uncorrelated, highly liquid assets such as gold. Today, trade tensions, the growth of populist politics and concerns about the economic and political outlook have encouraged investors to reexamine gold as a traditional hedge in times of turmoil
This sponsored content was not written by the editors of the newspaper, Pensions & Investments, and does not represent the views of the publication, or its parent company, Crain Communications.