For all times’ sake

12 February, 2019

Loy Cheow Chew was instrumental in the launch of the Commodities and Gold Group for the GIC, the Government of Singapore’s sovereign wealth fund. Loy Cheow led the Group from 2004 to 2008, helping to shape and drive the GIC’s policy on gold and other commodities. He believes that gold has a valuable role to play in sovereign wealth fund portfolios.

In 1953, the Kuwait Investment Authority established the first sovereign wealth fund (SWF) to invest its surplus oil revenues. Today, there are more than 70 SWFs, with collective assets under management of around US$8 trillion (tn).

Norway’s assets alone amount to more than US$1tn but many others, including the GIC, manage assets worth several billion dollars. As such, they are an influential force in today’s financial markets. But their investment criteria are rather different from central banks, their closest peer group.

Central banks, responsible for protecting their currency, focus on liquid assets so they can make large-scale sales if the need arises. SWFs manage their reserves withfuture generations in mind. Their horizons are exceptionally long term and many are focused primarily on security and returns. Nonetheless, there is a clear place for gold within the SWF portfolio.

A glance back in time helps to explain why. Throughout history, gold has been perceived as a safe haven and an asset of last resort, particularly during periods of political, economic and financial unrest.

When US President Nixon reneged on the gold standard in 1971, for example, the price of gold soared from a fixed rate of US$35/oz to a floating rate of more than US$800/oz in less than a decade. Demand was fuelled by the relative scarcity of gold, combined with growing concerns about the economic environment. Inflation, in particular, reached double digits during the 1970s and gold was seen as an effective hedge against depreciating fiat currencies.

History demonstrates that gold is uniquely placed when trust is shaken. And today, trust has been badly shaken.

Reserve managers, especially those without substantial gold holdings, were left scrambling for supplies. In the 1980s and 90s, however, many reserve managers sold gold, particularly those who had held it since before the 70s. Those who sold excessively were wrong-footed on three counts.

First, central banks began to cooperate to ensure that sales programmes were undertaken in an orderly fashion, starting with the Washington Agreement in September 1999. This helped to reverse the long bear market in gold.

Second, gold benefited from the broader bull market in commodities that began just a couple of years later.

And third, attitudes towards gold have shifted definitively since the Global Financial Crisis (Chart 1).


Chart 1: Gold price (1970–2018)

Chart 1: Gold price (1970–2018)

Sources: World Gold Council; Disclaimer

Data as of 1 December 2018


Shaken and stirred

The years leading up to the crisis were typified by “irrational exuberance”, as Alan Greenspan, former chairman of the US Federal Reserve, memorably put it. The crisis itself undermined investor faith in the entire financial system.

As banks collapsed, markets reeled and several countries battled to stay afloat, governments responded with waves of quantitative easing (QE). The rationale was clear – economies needed support to avoid prolonged recession. But the strategy had several notable consequences, in particular, a mistrust of central banks by foreign exchange and financial market participants.

For, not only did the world’s pre-eminent central bank, the US Federal Reserve, embark on a market support scheme that ballooned its balance sheet, but its fiscal partner, the US Treasury, engineered a bailout of some of the country’s leading banks. Europe followed suit, bailing out banks considered too big to fail and taking up QE with enthusiasm.

Investment in gold was a natural response. A supranational currency, gold does not depend on any sovereign authority and its value tends to rise as the circulation of fiat currencies soars. By 2011, therefore, the gold price had surged to almost US$1,900/oz.

The 1980 record of US$850/oz had now been surpassed. However, the price was still several hundred dollars below that peak, on an inflation-adjusted basis. It remains so to this day (Chart 2).


Chart 2: Inflation-adjusted gold price (1972–2018)

Chart 2: Inflation-adjusted gold price (1972–2018)

Sources: MacroTrends; Disclaimer

Data as of 1 December 2018


The 1970s and 80s were rocked by persistent bouts of inflation. But efforts to keep inflation under control succeeded in subsequent decades and inflationary fears were replaced by concerns about deflation or stagflation in the years following the financial crisis.

Today, who knows how or when the inflation dragon may return? Or how gold will respond if it does? If the past is any guide, inflation tends to alert investors to gold’s value as a wealth preservation tool, although other commodities may have similar properties.

Where gold comes into its own, however, is as an asset that carries no counterparty or credit risk, a supranational asset that exists independently of governments, banks and financial institutions, and an asset that was historically the collateral behind currency issuance.

Trust deficit

Over the years, return-focused SWFs have steered away from gold, because it offers neither coupons nor dividends. As history demonstrates, however, gold is uniquely placed when trust is shaken.

And today, trust has been badly shaken. The financial crisis exposed the moral hazard inherent in financial markets, where taxpayers were forced to subsidise bankers’ excessive risk-taking. Regulators have made a concerted effort to deliver change but many believe they should have shared the blame for the initial crisis, rather than escaping without penalty.

SWFs should consider allocating a percentage of their holdings to gold, as an allocation can provide a potential hedge against calamity, today or in the future.

There is also the fear that little has changed within the banking sector, even as years of austerity have fostered social inequality and fuelled discontent.

This perception of ‘us and them’ has had widespread repercussions, creating a more volatile geopolitical climate worldwide. The US has become unpredictable, particularly worrying as it is home to the world’s reserve currency, but other nations are in flux too, in Europe, Asia and Latin America.

So far, governments and central banks have been able to avoid financial meltdown, with the aid of QE and ultra-low interest rates. But there has been an erosion of trust.

As social unrest persists, political turmoil continues and the stewards of the world’s currencies continue to print money and keep interest rates at historically low levels, what might happen next? If misbehaving governments follow misbehaving bankers, there is no bailor of last resort.

For this reason alone, SWFs should consider allocating a percentage of their holdings to gold, as an allocation can provide a potential hedge against calamity, today or in the future.

After all, bonds and equities can slump as well as rise. And a currency is just an IOU. Gold is a permanent asset.

Important disclaimers and disclosures [+]Important disclaimers and disclosures [-]