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.6
- 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 Indian pension funds in particular, may increase the value of liabilities
- 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. (see 2020 Gold Outlook).
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 nontraditional assets among global pension funds increased from 7% in 1998 to 26% in 2018 (Chart 1).2
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 eight-fold over the same period.3
Chart 1: Investors continue to add alternative investments, including gold, to their portfolios*
Sources: World Gold Council, Willis Towers Watson; Disclaimer
*As of December 2018
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 (see Chart 13, and Chart 24 in the full report)
- 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 (see Chart 14 in the full report)
- 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 (see Chart 16 in the full report). 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 (see Chart 25, and Chart 26 in the full report)
- Monetary policy: persistently low interest rates reduce the opportunity cost of holding gold and highlight its attributes as a source of genuine, long-term returns, particularly when compared to historically high levels of global negative-yielding debt (see Chart 23 in the full report)
- Central bank demand: a surge of interest in gold among central banks across the world, commonly used in foreign reserves for safety and diversification, has encouraged other investors to consider gold’s positive investment attributes (see Chart 15 in the full report).
Gold’s strategic role
Gold is a clear complement to stocks, bonds and broad-based portfolios. A store of wealth and, a hedge against systemic risk, currency depreciation and inflation, gold has historically improved portfolios’ risk-adjusted returns, delivered positive returns, and provided liquidity to meet liabilities in times of market stress
1. A source of returns
Gold is long considered a beneficial asset during periods of uncertainty. Historically, it generated long-term positive returns in both good times and bad. Over the past decade, the price of gold has increased by an average 14.1% per year in INR since 1973 after Bretton Woods collapsed (Chart 17). 4 Gold’s longterm return has been comparable to Indian stocks and higher than Indian government bonds, also outperforming other major asset classes (Chart 2, Chart 17 and Chart 19 in the full report).
Gold is used to protect and enhance wealth over the long-term and it operates as a means of exchange, because it has global recognition and is no one’s liability. Gold is also in demand as a jewellery, valued by consumers across the world. And it is a key component in electronics.5 These diverse sources of demand differentiate gold from other investment assets. They also give it a particular resilience: the potential to deliver solid returns in good times and in bad (Focus 1).
Chart 2: Gold has delivered positive returns over the long run, outperforming key asset classes
Average annual return of key global assets
Sources: Bloomberg, CRISIL, Multi Commodity Exchange of India, Refinitiv Eikon, World Gold Council; Disclaimer
*As of 31 December 2019. Computations in Indian Rupee of total return indices for Bloomberg Barclays 1-3 year Indian Treasury Unhedged Index, S&P BSE India Government Bond Index, BSE Sensex, CRISIL Corporate Bond Index, Blended Commodity Index using MCX-ISI and MCX iComdex index and MCX India Gold Spot Index. For compounded annual growth rates download the full report to see (Chart 17), p13).
Beating inflation, combating deflation
Gold is long considered a hedge against inflation and the data confirms this. The average annual return of 10% since 1981, has outpaced the Indian consumer price index (CPI).7
Gold also protects investors against extreme inflation. In years when Indian inflation was higher than 6% gold’s price increased 11.5% on average (Chart 3). Over the long-term, therefore, gold has not just preserved capital but helped it grow.
Notably too, research by Oxford Economics shows that gold should do well in periods of deflation.8 Such periods are characterised by low interest rates, reduced consumption and investment, and financial stress, all of which tend to foster demand for gold.
Chart 3: Gold has historically rallied in periods of high inflation
Gold returns as a function of annual Indian inflation*
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council; Disclaimer
*Based on y-o-y changes of the India Gold Price and India CPI between 1981 and 2019.
**For each year on the sample, real return = (1+nominal return)/(1+inflation)-1.
Outperforming fiat currencies
Investor demand has been boosted by persistently low interest rates and concerns about the outlook for the dollar, as these factors affect the perceived opportunity cost of holding gold.
Historically, major currencies were pegged to gold. That changed with the collapse of Bretton Woods in 1971. Since then, gold has significantly outperformed all major currencies as a means of exchange (Chart 4). This outperformance was particularly marked immediately after the end of the Gold Standard and, subsequently, when major economies defaulted. A key factor behind this robust performance is that the supply growth of gold has changed little over time – increasing by approximately 1.6% per year over the past 20 years.9 By contrast, fiat money can be printed in unlimited quantities to support monetary policy, as exemplified by the Quantitative Easing (QE) measures in the aftermath of the global financial crisis.
Chart 4: Gold has outperformed all major fiat currencies over time
Relative value between major currencies and gold since 1900*
Sources: Bloomberg, Harold Marcuse – UC Santa Barbara, World Gold Council; Disclaimer
*As of 31 December 2019. Based on the annual average price of a currency relative to the gold price.
**The ‘Mark’ was the currency of the late German Empire. It was originally known as the Goldmark and backed by gold until 1914. It was known as the Papermark thereafter.
2. Diversification that works
The benefits of diversification are widely acknowledged - but effective diversifiers are hard to find. Many assets are increasingly correlated as market uncertainty rises and volatility is more pronounced, driven in part by risk-on/ risk-off investment decisions. As a result, many so-called diversifiers fail to protect portfolios when investors need them most.
Gold is different, in that its negative correlation to stocks and other risk assets increases as these assets sell off (Chart 5). The 2008-2009 financial crisis is a case in point. Stocks and other risk assets tumbled in value, as did hedge funds, real estate and most commodities, which were long deemed portfolio diversifiers. For example, the SENSEX fell by 56% from December 2007 to February 2009. Gold, by contrast, held its own and increased in price, rising 48% in INR over the same period.10
This robust performance is perhaps not surprising.
Gold has consistently benefited from “flight-to-quality” inflows during periods of heightened risk. It is particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses (Download the full report to see Chart 25) Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, undervalued and possibly mispriced.11,12
But gold’s correlation does not just work for investors during periods of turmoil. It can also deliver positive correlation with stocks and other risk assets in positive markets.
This dual benefit arises from gold’s dual nature: as an investment and an adornment. As such, the long-term price of gold is supported by income growth. Our analysis bears this out, showing that when stocks rally strongly, their correlation to gold can increase (Download the full report to see Chart 24 and Chart 26), likely driven by a wealth-effect supporting gold consumer demand as well as demand from investors seeking protection against higher inflation expectations.
Chart 5: Gold’s correlation with stocks helps portfolio diversification in good and bad economic times
Correlation between gold and SENSEX returns in various environments of stocks’ performance*
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council; Disclaimer
*As of 31 December 2019. Correlations computed using weekly returns based on the BSE Sensex and the LBMA Gold Price PM in Indian Rupees since January 1984. The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on BSE Sensex weekly return falling by more than two standard deviations (or ‘σ’) respectively, while the bottom bar corresponds to the BSE Sensex weekly return falling by more than three standard deviations. The standard deviation is based on the same weekly returns over the full period.
3. A deep and liquid market
The gold market is large, global and highly liquid.
We estimate that physical gold holdings by investors and central banks are worth approximately INR 265.7 trillion (tn) (INR 265.7 lakh crore) with an additional INR 68.3tn (INR 68.3 lakh crore) in open interest through derivatives traded on exchanges or the over-the-counter market.13
The gold market is also more liquid than several major Indian financial markets, including bonds and stocks, while trading volumes are similar to those of the S&P 500 and short-term US treasuries (Chart 6). Gold’s trading volumes averaged INR 10.3tn per day in 2019. During that period, over-the-counter spot and derivatives contracts accounted for INR 5.5tn and gold futures traded INR 4.6tn per day across various global exchanges. Gold trading volumes on MCX contributed to INR 61 billion (bn) per day. Gold-backed ETFs offer an additional source of liquidity, with the Indian-listed funds trading an average of INR 18mn per day.
The scale and depth of the market mean that it can comfortably accommodate large, buy-and-hold institutional investors. In stark contrast to many financial markets, gold’s liquidity does not dry up, even at times of acute financial stress.
Chart 6: Gold trades more than many other major financial assets
Average daily trading volumes in US dollars*
Sources: BSE, Department of Economic Affairs , Japan Securities Dealers Association, NSE, World Gold Council; Disclaimer
*Based on estimated one-year average trading volumes as of 31 December 2019, except for currencies that correspond to March 2019 volumes due to data availability.
**Gold liquidity includes estimates on over the counter (OTC) transactions and published statistics on futures exchanges, and gold-backed exchange-traded products. For methodology details visit the liquidity section at Goldhub.com.
4. Enhanced portfolio performance
Long-term returns, liquidity and effective diversification all benefit overall portfolio performance. In combination, they suggest that a portfolio’s risk-adjusted returns can be materially enhanced through the addition of gold.
Our analysis of investment performance over the past two, five and ten years underlines gold’s positive impact on an institutional portfolio. It shows that the average Indian pension fund would have achieved higher risk-adjusted returns if 5%, 7.5% or 10% of the portfolio were allocated to gold.(Chart 7) and (Table 1). The positive impact has been particularly marked since the global financial crisis.
Looking to the future, stronger dynamics apply. Our analysis shows that Indian Rupee-based investors can benefit from a material enhancement in performance if they allocate between 6% and 17% of a well-diversified portfolio to gold (Chart 8a).14
The amount of gold varies according to individual asset allocation decisions. Broadly speaking however, the higher the risk in the portfolio - whether in terms of volatility, illiquidity or concentration of assets - the larger the required allocation to gold, within the range in consideration, to offset that risk (Chart 8b).
Our analysis indicates that gold’s optimal weight in hypothetical portfolios is statistically significant even if investors assume an annual return for gold of between 2% and 4% - well below its actual long-term historical performance.
This works equally for investors who already hold other inflation-hedging assets, such as inflation-linked bonds,15 and for investors who hold alternative assets, such as real estate, private equity and hedge funds.16
Indian investors can diversify their portfolio by allocating in gold though multi-asset allocation funds (Focus 2).
Chart 7: Adding gold over the past decade would have increased risk-adjusted returns of a hypothetical Indian average pension fund portfolio
Performance of a hypothetical average pension fund (PF) portfolio with and without gold*
Sources: Bloomberg, CRISIL, World Gold Council; Disclaimer
*Based on performance between 31 December 2009 and 31 December 2019. The hypothetical Indian average pension fund portfolio is based on the allocation to various assets as per SBI Pension Fund for Central Government Scheme as of December 2019. Allocation is based on the investment guidelines of the Pension Fund Regulatory and Development Authority (PFRDA). It includes 11% allocation to stocks (BSE Sensex), 49% allocation to India Government Bond (S&P BSE India Government Bond Index), 37% allocation to corporate bond (CRISIL Corporate Bond Index) and 3% to cash (Bloomberg Barclays 1-3 year Indian Treasury Unhedged Index). The allocation to gold comes from proportionally reducing all assets. Risk-adjusted returns are calculated as the annualised return/annualised volatility. See important disclaimers and disclosures at the end of this report.
Table 1: Gold increases risk-adjusted returns by reducing portfolio volatility and drawdowns across various time horizons
Comparison of an average hypothetical Indian pension portfolio and an equivalent portfolio with 7.5% gold over the past two, five and ten years*
|No gold||7.5% gold||No gold||7.5% gold||No gold||
*As of 31 December 2019. The average hypothetical PF portfolio is based on Willis Tower Watson Global Pension Assets Study 2019 and Global Alternatives Survey 2017 and as described on (Chart 7). Returns are in INR. Ibid
Source: Bloomberg, ICE Benchmark Administration, World Gold Council
Chart 8a: Gold can significantly improve risk-adjusted returns of hypothetical portfolios across various levels of risk
(a) Long-run optimal allocations based on asset mix*
Sources: World Gold Council; Disclaimer
Chart 8b: Gold can significantly improve risk-adjusted returns of hypothetical portfolios across various levels of risk
(b) Range of gold allocations and the allocation that delivers the maximum risk-adjusted return for each hypothetical portfolio mix*
Sources: World Gold Council; Disclaimer
*Based on monthly total returns from December 2009 to December 2019 of Bloomberg Barclays 1-3 year Indian Treasury Unhedged Index, S&P BSE India Government Bond Index, BSE Sensex, CRISIL Corporate Bond Index, Blended Commodity Index using MCX-ISI and MCX iComdex index and MCX India Gold Spot Index. Each hypothetical portfolio composition reflects a percentage in stock relative to cash, bonds and gold. For example: 60% Fixed Income is a portfolio with 60% in bonds and cash, 40% in stocks, alternatives and gold. 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.
See important disclaimers and disclosures at the end of this report.
Focus 2: Multi-Asset Allocation Fund
The Securities and Exchange Board of India (SEBI) issued a notification in October 2017 to categorise and rationalise mutual fund schemes in India to bring uniformity in the characteristics of similar type of schemes launched by different Mutual Funds. Under the rationalisation, the schemes were broadly divided into the following groups: equity schemes, debt schemes, hybrid schemes, solution -oriented schemes and other schemes.
Multi-asset allocation funds fall in the hybrid category that can invest in at least three asset classes. As per SEBI regulations, a minimum of 10% allocation is required for each invested asset class. The inclusion of multiple asset classes may increase diversification and lower overall portfolio risk. The allowed asset classes include stocks, debt, gold, commodities, and REITs among others. Investments in gold can be made through physical gold, gold-backed ETFs, or other gold related investments (eg, derivatives, Sovereign Gold Bonds). As per the categorisation from SEBI, there are seven multi-asset allocation funds with total AUM of INR 132.3bn at end of 2019. Of those, five include an allocation to gold (Table 2).
Total AUM and percentage of portfolio allocated to gold*
|Funds list||AUM (INR bn)||Allocation to gold %|
|SBI Multi- Asset Fund||2.5||17.7%|
|HDFC Multi- Asset Fund||2.1||16.0%|
|ICICI Prudential Multi-Asset Fund||119.0||11.3%|
|Axis Triple Advantage Fund||3||13.6%|
|Quantum Multi-Asset Fund||0.2||15.8%|
*As of 31 January 2020.
Source: Factsheet of Individual Mutual Funds
Perceptions of gold have changed substantially over the past two decades, reflecting increased wealth in the East and a growing appreciation of gold’s role within an institutional investment portfolio worldwide.
Gold’s unique attributes as a scarce, highly liquid and un-correlated asset highlight that it can act as a genuine diversifier over the long term.
Gold’s position as an investment and Jewellery has allowed it to deliver average returns of approximately 9% over the past 10 years, comparable to stocks and more than bonds and commodities (Focus 3). (Chart 2)
Gold’s traditional role as a safe-haven asset means it can demonstrate its qualities during times of high risk. But gold’s dual appeal as an investment and a consumer good means it can generate positive returns in good times too.
This dynamic is likely to persist, reflecting persistent political and economic uncertainty, persistently low interest rates and economic concerns surrounding stock and bond markets (see 2020 Gold Outlook).
Overall, extensive analysis suggests that adding between 6% and 17% of gold to a Indian-rupee based portfolio could make a tangible improvement to performance and boost risk-adjusted returns on a sustainable, long-term basis. (see Chart 7).
Focus 3: Gold goes beyond commodities
Gold is often considered part of the broad commodity complex, whether as a component of a commodity index (e.g. S&P GSCI Index, Bloomberg Commodity Index), a security in an ETF or a future trading on a commodity exchange.
Gold shares some similarities with commodities. But there are several important differences:
- gold is a traditional safe-haven asset: scarce, yet highly liquid, it offers effective downside portfolio protection during difficult times
- gold is both an investment and a luxury good, which reduces its correlation to other assets
- the supply of gold is balanced, deep and broad, limiting uncertainty and volatility
- gold does not degrade over time, unlike several traditional commodities
These unique attributes set gold apart from the commodity complex. And our research suggests that a distinct allocation to gold can enhance the performance of portfolios with passive commodity exposures.17
Chart 9: Gold has outperformed all broad-based indices and all individual commodities
20-year commodity and commodity index returns
Sources: Bloomberg, World Gold Council; Disclaimer
Annualised returns in INR from December 1999 to December 2019. Indices include: S&P GS Energy Index, S&P GSCI Precious Metals Index, S&P GSCI Industrial Metals Index, S&P GSCI Non-Precious Metals Index, and MCX Gold Spot index (INR/10gram).
2Willis Towers Watson, Global Pension Assets Study 2018, February 2019 and Global Alternatives Survey 2017, July 2017. https://www.willistowerswatson.com/en-US/insights/2017/07/Global-Alternatives-Survey-2017
3As of 31 December 2019 based on the price of gold in Indian rupee.
4During the gold standard, the US dollar was backed by gold and the foreign currency exchange rates were dictated by the Bretton Woods System: https://www.imf.org/external/about/histend.htm. Generally, we analyse gold's performance from 1971, right after the end of the gold standard. In this instance, due to data availability for the INR exchange rate, our reference price data starts on January 1973.
7As of December 2019. We use 1981 as our starting point due to Indian CPI data availability.
8Oxford Economics, The impact of inflation and deflation on the case for gold, July 2011.
10Based on the MCX India Gold Spot Index from 31 December 2007 to 28 February 2009.
14Analysis based on the re-sampled efficiency methodology developed by Richard and Robert Michaud and praised as a robust alternative to traditional mean-variance optimisation. See Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008.
Important disclaimers and disclosures
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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.