Gold: the most effective commodity investment - 2021 Edition

Sectors: Investment

Our analysis suggests that gold is still the most effective commodity investment in a portfolio as it continues to stand apart from the commodities complex. It deserves to be seen as a differentiated asset as it has historically benefited from six key characteristics:

  • It has delivered superior absolute and risk-adjusted returns to other commodities over multiple time horizons
  • It is a more effective diversifier than other commodities
  • It outperforms commodities in low inflation periods
  • It has lower volatility
  • It is a proven store of value
  • It is highly liquid.

Commodities can be tactically relevant investments, but a strategic gold allocation on its own can supplement or replace a broad-based commodities investment.

Real assets have tended to do well in reflationary periods

Understanding historical asset performance during reflationary periods is relevant for understanding how assets could perform during the current period. We examine the performance of various assets during the last two periods of reflation, i.e. Consumer Price Index (CPI) trough to peak, and compare this to the current environment.2

The results confirm the idea that assets like Real Estate Investment Trusts (REITs) and Treasury Inflation-Protected Securities (TIPS) were solid performers, with commodities and gold performing well. Additionally, it confirms gold’s meaningful outperformance over equities and bonds. 

But what it also suggests is the potential upside in gold compared to how broad commodities have performed during the recent reflationary period. In the previous two periods, gold outperformed broad commodities. However, in the current environment, gold is down 10% compared to commodities, which are up substantially.3

Gold lagged other commodities beginning in May 2020, and has continued through the first half of 2021, but this is not unusual in commodity-led reflationary periods historically, as we addressed in our recent publication, Gold, commodities and reflation. Historically, gold lags initially, but catches up to most major commodity groups by the second and third years of a reflationary period.

Volatility has increased globally, but less so for gold

Volatility increased across major assets and commodities in 2020, driven by COVID-19-induced uncertainty, but less so for gold comparatively (Chart 1). A key reason for gold’s relative stability stems from its role as a diversifier in turbulent markets, as well as stronger left-tail correlation between many other commodities and risk-on assets.

Table 1: Gold historically lagged in commodity-led reflation periods but outperformed over the long run

Most recent reflationary periods in the US*

Start End REITs Value 
equities
Growth
equities
US
bonds
BCOM S&P
GSCI
Gold
Nov-01 Sep-06 39% 8% 0% 5% 20% 22% 24%
Jun-09 Apr-12 25% 16% 21% 7% 5% 7% 27%
Aug-20 Jun-21 28% 30% 19% -1% 29% 45% -10%

*As of 30 June 2021.
Source: Bloomberg, World Gold Council

 

Chart 1: Gold’s volatility increased less than that of equities and many commodities

Gold’s volatility increased less than that of equities and many commodities

Annualised volatility of gold and other assets in 2020 vs long-run averages*

Gold’s volatility increased less than that of equities and many commodities
Annualised volatility of gold and other assets in 2020 vs long-run averages*
*Daily annualised volatility of various asset classes in 2020 (dotted colour), versus ten-year average (solid colour). Data from 1 January 2020 to 31 December 2020 for 1-year volatility, and 1 June 2011 to 30 June 2021 for long-run average annualised volatility. On Goldhub.com see: Gold volatility. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*Daily annualised volatility of various asset classes in 2020 (hollow colour), versus ten-year average (solid colour). Data from 1 January 2020 to 31 December 2020 for 1-year volatility, and 1 June 2011 to 30 June 2021 for long-run average annualised volatility.
On Goldhub.com see: Gold volatility.
 

It is interesting to note that the increase in the volatility of the broader Bloomberg Commodity Index (BCOM) in 2020 was not as substantial as one may have expected. This is largely a function of the significant dispersion of commodity performance, particularly with oil performing so poorly, and other commodities like gold performing so well, evidenced by overall commodities returns of -24% and -3%, compared to a gold return of 25%.4 Simply put, commodities as a whole exhibited lower volatility than gold, but they did not protect the portfolio as well as gold (Chart 2).

 

Chart 2: Gold outperformed nearly every major commodity last year, also outpacing the negative returns of both major commodity indices

Gold outperformed nearly every major commodity last year, also outpacing the negative returns of both major commodity indices

2020 commodity returns*

Gold outperformed nearly every major commodity last year, also outpacing the negative returns of both major commodity indices
2020 commodity returns*
*Annualised data as of 31 December 2020. Indices include: S&P GSCI Official Close Index, S&P GSCI Agriculture Official Close Index, S&P GSCI Grains Official Close Index, S&P GSCI Livestock Index Spot, LBMA Gold Price PM USD, S&P GSCI Silver Official Close Index, Bloomberg Commodity Index, S&P GSCI Platinum Index, S&P GSCI Crude Oil Official Close Index, S&P GSCI Copper Official Close Index. On Goldhub.com see: Gold returns. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*Annualised data as of 31 December 2020. Indices include: S&P GSCI Official Close Index, S&P GSCI Agriculture Official Close Index, S&P GSCI Grains Official Close Index, S&P GSCI Livestock Index Spot, LBMA Gold Price PM USD, S&P GSCI Silver Official Close Index, Bloomberg Commodity Index, S&P GSCI Platinum Index, S&P GSCI Crude Oil Official Close Index, S&P GSCI Copper Official Close Index.

On Goldhub.com see: Gold returns.

Gold: not your typical commodity

Gold allocations of 2%–10% in an average institutional portfolio have provided better risk-adjusted returns than those with broad-based commodity allocations.7  

Investors have long recognised the benefits of investing in commodities. Over time, they have been shown to improve portfolio risk-adjusted returns, offering diversification, inflation protection, and an element of smoothing across economic cycles. 

Most investors access this asset class via commodity indices, which invariably include gold. 

But gold’s weighting within these indices undervalues its importance as a strategic portfolio component (Focus 1Table 3 and Table 4). Gold is, of course, a raw material used in the production of manufactured goods – the very definition of a commodity. But gold is much more than that. As both an investment and a consumer good, it is a multi-faceted asset that enjoys diverse supply and demand dynamics that play an important role in gold’s performance (see: Appendices III and IV in the full report), for more information). And as mentioned above, there are six main differentiators between gold and the broader commodities complex.

Better returns, effective diversification

Outperforming commodities

Gold has performed broadly in line with the S&P 500 over the long term, delivering average annual returns of 10.8% since the elimination of the gold standard in 1971 and a compound annual return of 7.9% (Chart 16, Appendix I in the full report).

But when compared to commodities, gold has outperformed not only broad-based indices but sub-indices and most individual commodities too. Nearly all sub-indices have fallen over the past five years. But gold has risen during that time. Gold has also outperformed major commodity sub-indices over the past 10 and 20 years (Chart 3), and outperformed most individual commodities, many of which have delivered negative returns in recent decades.

Diversification that counts

Gold has important diversification properties that come into their own during periods of systemic risk. 

Gold has little to no correlation with many other assets, including commodities (Chart 6 and Chart 20, Chart 21, Table 7, Appendix I in the full report) during times of stress. Crucially, however, the correlation is dynamic, changing across economic cycles to the benefit of investors. 

Like other commodities, gold is positively correlated to stocks during periods of economic growth when equity markets tend to rise. However, gold is also negatively correlated with other assets during risk-off periods, protecting investors against tail risks (Chart 4, and Chart 5), and other events that can have a significant negative impact on capital or wealth – a protection not always present in other commodities.

This dynamism reflects gold’s dual nature as both a consumer good and an investment. When economic conditions are benign, expenditure tends to increase on items such as jewellery or technological devices, and this works in gold’s favour. During times of systemic risk, however, market participants seek high-quality, liquid assets that preserve capital and minimise losses. This can also benefit gold by boosting investment demand and driving up prices. In the Q4 2018 global equity selloff, for example, the S&P 500 fell 15% and commodities fell 9%, yet gold rose 8%. And in the 2020 COVID selloff, the S&P 500 fell 20%, commodities fell 17%, while gold returned 2%. In both recent cases, gold not only protected portfolio assets but also delivered positive returns, while broader commodities behaved more like a risk-on asset.8  

Gold is also a more effective diversifier than other precious metals. While gold’s correlation to silver and platinum has been positive during periods of growth, it has decreased during market downturns as these other metals depend, to a greater extent, on industrial demand. Also, when compared to other metals, gold is much less dependent on the technology/industrial areas of the market in terms of demand, which can be highly cyclical (Chart 24, Appendix II in the full report)

 

Chart 3: Gold has outperformed commodity sub-indices over the trailing 5-, 10-, and 20-year periods

Gold has outperformed commodity sub-indices over the trailing 5-, 10-, and 20-year periods

Commodity sub-index returns*

Gold has outperformed commodity sub-indices over the trailing 5-, 10-, and 20-year periods
Commodity sub-index returns*
*Annualised returns through 30 June 2021. Indices include: S&P GS Precious Metals Index, S&P GS Industrial Metals Index, S&P GS Grains Index, S&P GS Agriculture Index, S&P GS Livestock Index, S&P GSCI Index, Bloomberg Commodity Index, Gold (US$/oz) London PM fix On Goldhub.com see: Gold returns. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*Annualised returns through 30 June 2021.
Indices include: S&P GS Precious Metals Index, S&P GS Industrial Metals Index, S&P GS Grains Index, S&P GS Agriculture Index, S&P GS Livestock Index, S&P GSCI Index, Bloomberg Commodity Index, Gold (US$/oz) London PM fix
On Goldhub.com see: Gold returns.
 

Gold behaves – and is used – as a safe-haven in periods of systemic risk…

 

Chart 4: Gold, unlike commodities, tends to perform positively when volatility increases

Gold, unlike commodities, tends to perform positively when volatility increases

Performance of stocks, gold, commodities, and VIX during periods of systemic risk*

Gold, unlike commodities, tends to perform positively when volatility increases
Performance of stocks, gold, commodities, and VIX during periods of systemic risk*
*The VIX is available only after January 1990. For events occurring prior to that date, annualised 30-day S&P 500 volatility is used as a proxy. Dates used: Black Monday: 9/1987–11/1987; LTCM: 8/1998; Dot-com: 3/2000–3/2001; September 11: 9/2001; 2002 recession: 3/2002–7/2002; Great Recession: 10/2007–2/2009; Sovereign debt crisis I: 1/2010–6/2010; Sovereign debt crisis II: 2/2011–10/2011; 2018 Pullback 10/2018–12/2018; COVID-19: 2/2020–3/2020. Commodities is the Bloomberg Commodity Index. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*The VIX is available only after January 1990. For events occurring prior to that date, annualised 30-day S&P 500 volatility is used as a proxy. Dates used: Black Monday: 9/1987–11/1987; LTCM: 8/1998; Dot-com: 3/2000–3/2001; September 11: 9/2001; 2002 recession: 3/2002–7/2002; Great Recession: 10/2007–2/2009; Sovereign debt crisis I: 1/2010–6/2010; Sovereign debt crisis II: 2/2011–10/2011; 2018 Pullback 10/2018–12/2018; COVID-19: 2/2020–3/2020. Commodities is the Bloomberg Commodity Index.

 

 

Chart 5: Gold has acted as a better diversifier than commodities and treasuries during strong equity selloffs

Gold has acted as a better diversifier than commodities and treasuries during strong equity selloffs

Correlation between gold, commodities and treasuries with US stock returns, in various environments of equities’ performance*

Gold has acted as a better diversifier than commodities and treasuries during strong equity selloffs
Correlation between gold, commodities and treasuries with US stock returns, in various environments of equities’ performance*
*As of 31 December 2020. Correlations computed using weekly returns based on the Bloomberg Commodity Index, Bloomberg Barclays US Treasury Index, and the LBMA Gold Price PM since January 1973. The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on S&P 500 weekly return falling by more than two standard deviations (or ‘’) respectively, while the bottom bar corresponds to the S&P 500 weekly return decreasing by more than three standard deviations. The standard deviation is based on the same weekly returns over the full period. On Goldhub.com see: Gold correlation. Source: Bloomberg, ICE Benchmark Administration, World Gold Council

Sources: Bloomberg, ICE Benchmark Administration, World Gold Council; Disclaimer

*As of 31 December 2020. Correlations computed using weekly returns based on the Bloomberg Commodity Index, Bloomberg Barclays US Treasury Index, and the LBMA Gold Price PM since January 1973. 
The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on S&P 500 weekly return falling by more than two standard deviations (or ‘σ’) respectively, while the bottom bar corresponds to the S&P 500 weekly return decreasing by more than three standard deviations. The standard deviation is based on the same weekly returns over the full period.

On Goldhub.com see: Gold correlation.
 

Oil and gold remain largely unrelated

Gold and oil prices are not correlated, contrary to popular belief. Part of this misunderstanding is related to the size and scope of both assets, their global importance, broad commodities grouping, and the fact they are both generally priced in US dollars. At times, the two commodities move in the same direction, at other times in opposite directions (Chart 6), but there is no consistent relationship between the two. Oil tends to behave more like a risky asset, while gold is widely regarded as a risk-off asset (Chart 20, Appendix I in the full report)

 

Chart 6: Over the past 48 years, gold exhibits little to no consistent correlation to oil on a two-year rolling monthly basis 

Over the past 48 years, gold exhibits little to no consistent correlation to oil on a two-year rolling monthly basis 

Correlation between gold and oil*

Over the past 48 years, gold exhibits little to no consistent correlation to oil on a two-year rolling monthly basis 
Correlation between gold and oil*
*As of 30 June 2021. Data is calculated using the rolling two-year correlation of monthly returns of oil and gold. The LBMA PM fix price is used for the price of gold, and the oil prices are determined via the Bloomberg Historical Oil Price Index as well as the Bloomberg WTI Crude Oil Sub Index Total Return. On Goldhub.com see: Gold correlation. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*As of 30 June 2021. 

Data is calculated using the rolling two-year correlation of monthly returns of oil and gold. The LBMA PM fix price is used for the price of gold, and the oil prices are determined via the Bloomberg Historical Oil Price Index as well as the Bloomberg WTI Crude Oil Sub Index Total Return.

On Goldhub.com see: Gold correlation.

Lower volatility and a store of value in all inflationary periods

Gold is less volatile than most individual commodities and broad commodity indices (Chart 7). It is also less volatile than equities: from individual stocks and industry sectors to indices such as the Global MSCI World Index (Chart 1). As such, gold can enhance portfolio stability and improve risk-adjusted returns. 

 

Chart 7: Gold is less volatile than most major commodity indices

Gold is less volatile than most major commodity indices

10-year gold and commodities volatility*

Gold is less volatile than most major commodity indices
10-year gold and commodities volatility*
*30 June 2011 to 30 June 2021 annualised weekly volatility of various commodities. On Goldhub.com see: Gold volatility. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*30 June 2011 to 30 June 2021 annualised weekly volatility of various commodities.

On Goldhub.com see: Gold volatility.

 

Protecting against inflation

Commodities are often used for diversification during periods of high inflation. While it is true that commodities have performed well during inflationary periods, gold has performed better. And in periods of low inflation, commodities delivered negative nominal returns, while gold posted positive returns, reflecting increased demand when economic conditions are robust (Chart 8).  

This behaviour is particularly relevant today. Despite a recent uptick, current inflation expectations are low from a historical perspective, so gold should outperform other commodities. Future expectations suggest a growing risk of higher inflation; this should also drive demand for gold, as it has outperformed commodities in both moderate- and high- inflationary periods.

 

Chart 8: Gold and broader commodities perform well in high inflation environments, but commodities break down in low inflation markets

Gold and broader commodities perform well in high inflation environments, but commodities break down in low inflation markets

Gold and commodity returns as a function of inflation*

Gold and broader commodities perform well in high inflation environments, but commodities break down in low inflation markets
Gold and commodity returns as a function of inflation*
*Based on y-o-y changes of the LBMA Gold Price, Bloomberg Commodity Index and US CPI between 1971 and 2020. Number of observations for each tranche: Low = 10, Moderate = 22, High = ## Source: Bloomberg, Bureau of Labour Statistics, ICE Benchmark Administration, World Gold Council

Sources: Bloomberg, Bureau of Labour Statistics, ICE Benchmark Administration, World Gold Council; Disclaimer

*Based on y-o-y changes of the LBMA Gold Price, Bloomberg Commodity Index and US CPI between 1971 and 2020. Number of observations for each tranche: Low = 10, Moderate = 22, High = 12. The buckets were determined based on a 2% Fed target rating, a recent CPI number above 5% and a proportional amount of observations in each tranche. The results are consistent when adjusting tranche levels moderately.

Gold as a store of value

Gold has a long and influential role as a monetary asset. Other metals, including silver and copper, have historically been used as currency but gold’s role in the monetary system is far more extensive as it has been used for thousands of years. Considered a rare and precious asset for centuries, gold was a logical choice as a currency anchor, and it performed this role until the US came off the gold standard in 1971.9 As such, gold made an important contribution to global economic architecture and, to this day, is considered a valuable international asset. Namely, it protects against currency declines and is the only precious metal used as a reserve asset (Chart 18, Appendix I in the full report). Prior to 1971, major commodities enjoyed periods where their value in gold terms reflected inflation and increased, while the price of gold was pegged to the US dollar. After 1971, when the price of gold was able to float, the value of commodities in gold terms fell sharply. 

Although gold no longer plays a direct role in the international monetary system, central banks and governments still hold extensive gold reserves (Table 10) to preserve national wealth and protect against economic instability. Central banks are buying gold at an ever-increasing pace. In 2018 alone, they purchased more gold than at any time since the end of the gold standard – and they have been net buyers for 11 straight years.10 Today, gold is the third largest reserve asset globally, following US dollar- and euro-denominated assets.

Gold is liquid and less impacted by futures storage and roll costs

Global liquidity on a physical-linked market

The gold market is robust and highly liquid. On the futures markets, daily volumes average US$69bn (Chart 22 and Table 8, Appendix II in the full report), second only to oil on US exchanges over the past 10 years (Table 9, Appendix II in the full report and Chart 9). It is worth noting that in 2020, amid significant market volatility, gold traded more each day in the US (at US$54bn) than either WTI Crude oil (US$42bn) or Brent Crude oil (US$36bn). On the over-the-counter (OTC) market, estimated volumes are even higher, at around US$110bn.11 There is a thriving physical gold-backed ETF market too, with daily volumes averaging US$1bn. Overall, average daily trading in the global gold market ranges between US$140bn and US$200bn (Chart 10, Table 8, Appendix II in the full report).

This extensive liquidity allows investors to access gold in a range of ways – which are particularly important when compared to other commodities – and highlights how gold operates within a differentiated market (Focus 2). 
 

 

Chart 9: Daily Volume in gold futures is higher than all commodities except oil on the COMEX

Daily volume in gold futures is higher than all commodities except oil on the COMEX

Average daily trading volume in US dollars over the past 10 years*

Daily volume in gold futures is higher than all commodities except oil on the COMEX
Average daily trading volume in US dollars over the past 10 years*
*Based on 10-yr average trading volumes as of June 2021. Source: Bloomberg, COMEX, World Gold Council

Sources: Bloomberg, COMEX , World Gold Council; Disclaimer

*Based on 10-yr average trading volumes as of June 2021. 

 

Storage costs hurt many commodity futures returns, but only slightly for gold

Many investors access commodity markets via futures contracts. Because futures contracts are based on the expected price at a certain point down the road, as well as the costs of carry, storage, and interest, investors are exposed to an additional source of variability: the shape of the futures curve. 

In general, futures curves have less of an impact on gold and other precious metals returns relative to most other commodities. Storage costs in particular account for a large proportion of the futures cost or cost of carry. But the storage costs of physical gold are negligible compared to those of other metals, while commodities such as natural gas incur extremely expensive storage costs, with most of those securities not settling for physical delivery. These costs are typically represented by a futures curve in contango, when futures prices are higher than spot prices.12, 13

The shape of the curve, combined with the fact that futures contracts are typically rolled over or settled in cash, creates discrepancies between spot price returns and total returns. This difference can be very large in certain commodity markets, yet futures returns are not necessarily higher than spot returns. 

The oil market between June 2001 and June 2021 exemplifies this point (Chart 12, Table 6, Appendix I in the full report). Cumulative total returns based on spot were 88%; based on the futures markets, they were -111%, a by-product of the continuous rolling costs of maintaining a position.14  During the same period, gold’s spot return was 194% and the futures return was 189%. In fact, the roll cost has averaged approximately 25bps a year over the past 20 years, compared to 6% for the S&P GSCI. This reflects two important differentials between gold and other commodities. First, the shape of the gold futures curve tends to be flat at the most actively traded front end of the curve. Second, most investors either trade in spot or can potentially take physical delivery of futures contracts (although this can be quite costly and happens rarely). It is worth noting that the Bloomberg Precious Metals Sub-index and gold futures deliver similar performances over the long run, largely because nearly 82% of the Sub-index is comprised of gold futures.

 

Chart 12: When considering total returns, gold futures far surpass that of other commodities

When considering total returns, gold futures far surpass that of other commodities

Spot and total returns for gold and broad commodity sub-classes over the past 10 years*

When considering total returns, gold futures far surpass that of other commodities
Spot and total returns for gold and broad commodity sub-classes over the past 10 years*
*Data from 30 June 2001 to 30 June 2021. On Goldhub.com see: Gold returns. Source: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*Data from 30 June 2001 to 30 June 2021.
On Goldhub.com see: Gold returns.

Gold – efficient, effective, and under-represented

Despite gold’s unique and differentiating properties, investors often cluster it into a commodities bucket that frequently represents a small allocation within their overall portfolio. Furthermore, the amount of gold allocated to this smaller commodities bucket is usually just a fraction of the bucket itself, further diminishing the weight. 

Investors who access commodities via a broad-based index often assume they have an appropriate allocation to gold. In fact, most broad-based commodity indices have a very small allocation to gold. Indices such as the S&P GSCI or BCOM typically allocate between 6% and 15% to gold (Table 2, Table 3, and Table 4).15 While we previously noted that these allocations are trending higher, we do not believe such weightings provide an appropriate exposure to gold, particularly as commodities tend to represent a small portion of an investor’s overall portfolio.

Table 3: Gold is a small component in the S&P GSCI Index

S&P GSCI sector weights*

   
Energy 54%
Agriculture 19%
Livestock 8%
Industrial Metals 12%
Precious Metals 7%
    Gold 6.27%

*Weights as of 31 January 2021; gold weighting is a sub-weight of Precious Metals.

Source: S&P Global, World Gold Council

Table 4: Gold has a more prominent yet still small weight in the Bloomberg Commodity Index

Bloomberg Commodity Index sector weights*

Sector Weight
Energy 30%
Grains 23%
Industrial Metals 15%
Precious Metals 19%
    Gold 15%
Softs 7%
Livestock 6%

*Weights as of 30 June 2021; gold weighting is a sub-weight of Precious Metals.

Source: Bloomberg, World Gold Council

Under-allocated to gold: a missed opportunity?

Commodity exposure is generally limited to less than 10% of an investment portfolio, and in many cases this is much lower.16 Gold usually accounts for less than 10% of that amount – in other words, most portfolios will have less than 1% exposure to gold. 

While commodity exposure does provide diversification benefits from a lower volatility perspective, our analysis suggests that adding a 2%–10% portfolio allocation to commodities decreased risk-adjusted returns over the past 20 years. However, gold can do much more. Looking back over the past two decades, replacing or supplementing a commodities allocation with gold provided two key benefits: it increased absolute returns and reduced portfolio volatility when compared to a portfolio with no commodity exposure or with only broad-based commodity exposure (Chart 13 and Chart 14).

 

Chart 13: Gold allocations improved absolute and risk-adjusted returns more than commodities over the past 20 years

Gold allocations improved absolute and risk-adjusted returns more than commodities over the past 20 years

Performance of a hypothetical average institutional portfolio with and without commodities or gold*

Gold allocations improved absolute and risk-adjusted returns more than commodities over the past 20 years
Performance of a hypothetical investment portfolio with and without commodities or gold*
*As of 30 June 2021. Risk-adjusted return defined as portfolio return divided by annualised volatility and based on the total return indices and benchmarks listed below using data from June 2001 to June 2021 assuming quarterly rebalancing. A 0% allocation denotes is based on a hypothetical average portfolio with market data from JP Morgan Asset Management and Coalition Greenwich (formerly Greenwich Associates). as well as data from Blackrock. It includes a 58% allocation to stocks (30% Russell 3000, 19% MSCI ACWI ex US, 9% FTSE Nareit REITs Index), 28% allocation to fixed income (20% Bloomberg Barclays US Aggregate, 5% S&P/LSTA Leveraged Loan Index, 3% Bloomberg Barclays US Corporate High Yield Index), and 14% allocation to alternatives (10% S&P Listed Private Equity Index, 4% Hedge Fund HFRI Index).

*As of 30 June 2021.

Risk-adjusted return defined as portfolio return divided by annualised volatility and based on the total return indices and benchmarks listed below using data from June 2001 to June 2021 assuming quarterly rebalancing. 

A 0% allocation denotes a hypothetical average portfolio with market data from JP Morgan Asset Management and Coalition Greenwich (formerly Greenwich Associates). as well as data from Blackrock. It includes a 58% allocation to stocks (30% Russell 3000, 19% MSCI ACWI ex US, 9% FTSE Nareit REITs Index), 28% allocation to fixed income (20% Bloomberg Barclays US Aggregate, 5% S&P/LSTA Leveraged Loan Index, 3% Bloomberg Barclays US Corporate High Yield Index), and 14% allocation to alternatives (10% S&P Listed Private Equity Index, 4% Hedge Fund HFRI Index).

 

Chart 14: Gold improves absolute and risk-adjusted returns

Gold improves absolute and risk-adjusted returns

Performance of a hypothetical average institutional portfolio with and without commodities or gold*

Gold improves absolute and risk-adjusted returns
Performance of a hypothetical investment portfolio with and without commodities or gold*
*As of 30 June 2021. Based on monthly data from June 2001 to June 2021 assuming quarterly rebalancing. See Chart 13 for portfolio indices and allocations. Source: Bloomberg, ICE Benchmark Administration, World Gold Council

Sources: Bloomberg, ICE Benchmark Administration, World Gold Council; Disclaimer

*As of 30 June 2021.

Based on monthly data from June 2001 to June 2021 assuming quarterly rebalancing. See Chart 13 for portfolio indices and allocations.
 

Gold improves risk-adjusted returns across portfolio structures

To determine the optimum allocation to gold it is useful not only to compare gold with other commodities, but also to consider the broader impact that gold can have on portfolios. The World Gold Council has conducted analysis, based on typical US investment portfolio allocations of varying risks, and back-tested the ideal allocations of gold for each investment objective (Chart 19, Appendix I in the full report). Our analysis indicates that US dollar-based investors can meaningfully improve the performance of a well-diversified portfolio by allocating between 2% and 10% to gold (Chart 15 and Table 5).

Broadly speaking, the higher the risk in the portfolio – whether in terms of volatility, illiquidity, or concentration of assets – the larger the required allocation to gold to offset that risk.

Table 5: Gold allocations improve risk-adjusted returns

Hypothetical resampled returns, volatility, gold weights, and risk-adjusted-returns*

Portfolio Return Volatility Gold weight Risk-adjusted returns
Current average portfolio 5.2% 9.1% 0.0% 0.57
Equivalent % return 5.2% 7.8% 3.8% 0.67
Highest risk-adjusted returns 5.9% 8.4% 4.7% 0.70
Max absolute return 6.1% 8.9% 5.9% 0.69

*Based on 20-year historical returns, volatility, and correlation, resampled using Blackrock’s expected asset returns and volatility over the coming decade. 

Source: World Gold Council

 

Chart 15: Gold can significantly improve risk-adjusted returns of hypothetical average institutional portfolios across various levels of risk

Gold can significantly improve risk-adjusted returns of hypothetical investment portfolios across various levels of risk

Range of gold allocations and the allocation that delivers the maximum risk-adjusted return for each hypothetical portfolio mix*

Gold can significantly improve risk-adjusted returns of hypothetical investment portfolios across various levels of risk
Range of gold allocations and the allocation that delivers the maximum risk-adjusted return for each hypothetical portfolio mix*
*Based on monthly data from 30 June 2001 to 30 June 2021 assuming quarterly rebalancing. See Chart 13, pX and Table 5 for portfolio indices and allocations. ‘Max absolute return’ represents the highest expected absolute return in percentage terms based on the analysis. ‘Highest risk-adjusted returns’ represents the highest risk-adjusted returns for a given portfolio. ‘Equivalent return %’ represents the portfolio anticipated volatility for a portfolio with the same expected return of a current US pension fund. ‘Current average portfolio is the current weightings resampled with no gold exposure. Analysis based on New Frontier Advisors Resampled Efficiency. For more information see Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008. Source: World Gold Council

Sources: World Gold Council; Disclaimer

*Based on monthly data from 30 June 2001 to 30 June 2021 assuming quarterly rebalancing. See Chart 13, and Table 5 for portfolio indices and allocations.

‘Max absolute return’ represents the highest expected absolute return in percentage terms based on the analysis.
‘Highest risk-adjusted returns’ represents the highest risk-adjusted returns for a given portfolio.

‘Equivalent % return’ represents the portfolio anticipated volatility for a portfolio with the same expected return of a current US pension fund.

‘Current average portfolio is the current weightings resampled with no gold exposure.

Analysis based on New Frontier Advisors Resampled Efficiency. For more information see Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008.
 

 

Conclusion

A commodity is defined as an economic good, which is valued and useful and has little or no difference in composition or quality regardless of the place of production. While gold fits this definition, its market dynamics and the diversity of its application make it very different from other commodities. 

This difference is underlined by gold’s robust performance profile in terms of returns, volatility, and correlation. Taken together, these characteristics produce a more diversified portfolio than one with a simple, broad-based commodities exposure. 

Looking at other commodities, some can be considered luxury goods, some have technological applications, and some are basic, everyday products. Some are used to hedge against inflation, some protect against currency devaluation, and all provide a degree of diversification in an investment portfolio. However, only gold performs all these functions.

Indices such as the S&P GSCI or the Bloomberg Commodity Index are widely used by investors as benchmarks for their commodity allocations. While gold’s weight in these indices is increasing, it remains too low. More importantly, we find that under these conditions, an investor who only holds gold via a diversified commodities index will not achieve optimal returns (per unit of risk) or minimise expected losses.

Implementing an outright or supplemental position to gold reduces risk without diminishing long-term expected returns. In particular, strategic allocations ranging from 2% to 10% can significantly improve and protect the performance of an investment portfolio, while providing the exposure desired by the commodities investment itself.

1“Rethink, Rebalance, Reset: Institutional Portfolio Strategies for the Post-Pandemic Period”, July 2021, Coalition Greenwich (formerly Greenwich Associates)

1“Rethink, Rebalance, Reset: Institutional Portfolio Strategies for the Post-Pandemic Period”, July 2021, Coalition Greenwich (formerly Greenwich Associates)

2Using National Bureau of Economic Research (NBER) recession index (USRINDEX) via Bloomberg to determine analysis starting points. In our analysis, a reflation begins during the last month of the NBER recession and is loosely characterised as an environment of resurgent economic growth twinned with rising inflation and interest rates.

331 August 2020 to 30 June 2021.

4Total returns for the S&P GSCI and Bloomberg Commodity Index for 2020, respectively.

5S&P GSCI is a world production-weighted commodity index based on the average of the previous five years.

6Analysis based on New Frontier Advisors Resampled Efficiency, including individual and sub-index commodities. For more information see Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008.

7The average hypothetical average institutional portfolio is based on market data from JP Morgan Asset Management and Coalition Greenwich (formerly Greenwich Associates). It includes a 58% allocation to stocks (30% Russell 3000, 19% MSCI ACWI ex US, 9% FTSE Nareit REITs Index), 28% allocation to fixed income (20% Bloomberg Barclays US Aggregate, 5% S&P/LSTA Leveraged Loan Index, and 3% Bloomberg Barclays US Corporate High Yield Index), 14% allocation to alternatives (10% S&P Listed Private Equity Index, 4% Hedge Fund HFRI Index).

82018 pullback: 1 October 2018–31 December 2018; 2020 pullback: 31 January 2020–31 March 2020.

9During the gold standard, the US dollar was backed by gold, and the foreign currency exchange rates were dictated by the Bretton Woods System. In August 1971, the Nixon Administration announced the halt of the free conversion between the US dollar and gold catalysing the collapse of the gold standard and, subsequently, the Bretton Woods system.

10On Goldhub.com see: Gold supply and demand statistics.

11Note that these estimates are subject to periodical historical revisions as more data becomes available. See details Gold trading volumes on goldhub.com for methodology

12Contango is a situation where the futures price of a commodity is higher than the spot price. Contango usually occurs when an asset price is expected to rise over time. This results in an upward sloping forward curve, which can increase the cost of maintaining exposure to a particular asset.

13The spot price is the current price an investor would pay to acquire a commodity immediately. Spot price is frequently used with commodities because most commodities trade both on the ‘spot market’ and ‘futures market’.

14An investor is able to lose more than 100% of the initial investment—in this case 111% -- because futures positions do not effectively allow for a buy-and-hold strategy, forcing frequent rebalances where additional money inflows are required to maintain the same investment size.

15Determinants and weights in the Bloomberg Commodity Index include economic significance, diversification, continuity, and liquidity.

16A recent study by Coalition Greenwich (formerly Greenwich Associates), in conjunction with the World Gold Council, found that institutional investors expected to allocate 2% to commodities in their portfolios.

17Expected returns/volatility from Blackrock by asset class: Russell 3000: 5.1%/15.4%; MSCI ACWI ex US: 6.6%/15.4%; FTSE Nareit REITs Index: 5.0%/17%; Bloomberg Barclays US Aggregate: 1.1%/4.3%; S&P/LSTA Leveraged Loan Index: 7.0%/7.0%; Bloomberg Barclays US Corporate High Yield Index: 3.0%/8.9%; S&P Listed Private Equity Index: 12%/10%; Hedge Fund HFRI Index: 5%/6%; LBMA Gold Price PM: 5%/17%.

Important disclaimers and disclosures

© 2021 World Gold Council. All rights reserved. World Gold Council and the Circle device are trademarks of the World Gold Council or its affiliates.

All references to LBMA Gold Price are used with the permission of ICE Benchmark Administration Limited and have been provided for informational purposes only. ICE Benchmark Administration Limited accepts no liability or responsibility for the accuracy of the prices or the underlying product to which the prices may be referenced. Other content is the intellectual property of the respective third party and all rights are reserved to them. 

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The use of the statistics in this information is permitted for the purposes of review and commentary (including media commentary) in line with fair industry practice, subject to the following two pre-conditions: (i) only limited extracts of data or analysis be used; and (ii) any and all use of these statistics is accompanied by a citation to World Gold Council and, where appropriate, to Metals Focus, Refinitiv GFMS or other identified copyright owners, as their source. World Gold Council is affiliated with Metals Focus.

Neither the World Gold Council nor any of its affiliates (collectively, “WGC”) guarantees the accuracy or completeness of any information. WGC does not accept responsibility for any losses or damages arising directly or indirectly from the use of this information.

This information is for educational purposes only. Nothing contained herein is intended to constitute a recommendation, investment advice, or offer for the purchase or sale of gold, any gold-related products or services or any other products, services, securities or financial instruments (collectively, “Services”). This information does not take into account any investment objectives, financial situation or particular needs of any particular person.    

By receiving this information, you agree with the intended purpose of this information as being for educational purposes only.  Diversification does not guarantee any investment returns and does not eliminate the risk of loss.    

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This information contains forward-looking statements, such as statements which use the words “believes”, “expects”, “may”, or “suggests”, or similar terminology, which are based on current expectations and are subject to change. Forward-looking statements involve a number of risks and uncertainties. There can be no assurance that any forward-looking statements will be achieved. WGC assumes no responsibility for updating any forward-looking statements.

Information regarding QaurumSM and the Gold Valuation Framework 

Note that the resulting performance of various investment outcomes that can generated through use of Qaurum, the Gold Valuation Framework and other information are hypothetical in nature, may not reflect actual investment results and are not guarantees of future results. Diversification does not guarantee investment returns and does not eliminate the risk of loss.  World Gold Council and its affiliates and subsidiaries (collectively, “WGC”) provide no warranty or guarantee regarding the functionality of the tool, including without limitation any projections, estimates or calculations.

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