Gold allocations of 2%-10% in a typical pension portfolio1 have provided better risk-adjusted returns than those with broad-based commodity allocations
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 asset (Table 1 and Table 2). 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. Gold is an investment as much as 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 Appendix II for more information).
Standing apart from the commodities complex, gold deserves to be seen as a differentiated asset as it has historically benefited from six key characteristics.
- Gold has delivered better long-term, risk-adjusted returns than other commodities
- Gold is a more effective diversifier than other commodities
- Gold outperforms commodities in low inflation periods
- Gold has lower volatility
- Gold is a proven store of value
- Gold is highly liquid
Ultimately, commodities can be a relevant tactical asset, but a strategic gold allocation can supplement or replace a broad-based investment in commodities alone, as it may offer more widespread benefits (Chart 15).
Better returns, effective diversification
Gold as an investment has performed broadly in line with the S&P 500 over the long term, delivering average annual returns of 10.4% since the elimination of the gold standard in 1971 (Chart 1), and a compound annual return of 7.6% (Chart 16, Appendix I).
But, when compared to commodities, gold has outperformed not only broad-based indices but sub-indices and most individual commodities too. All sub-indices, including precious metals, 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 2), and outperformed most individual commodities, many of which have delivered negative returns in recent decades (Chart 17, Appendix I).