US edition - Individual investors

Sectors: Investment

New decade, renewed challenges

As the new decade begins, investors face an expanding list of challenges around asset management and portfolio construction. 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

Investors have embraced alternatives to traditional stock and bond investments in pursuit of diversification and higher risk-adjusted returns. The share of non-traditional assets among global pension funds, for example, increased from 7% in 1998 to 23% in 2019 – this is 30% in the US2 (Chart 1). And a similar pattern can be seen in the portfolio composition of individual investors.3 

 

Chart 1: [US -ind] Investors continue to add alternative investments, including gold, to their portfolios

Sources: World Gold Council, Willis Towers Watson; Disclaimer

*As of December 2019.

 

Gold allocations have been recipients of this shift. Gold 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.4

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
  • 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
  • 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.

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. Looking back almost half a century, the price of gold has increased by an average of 10% per year since 1971 when the gold standard collapsed.5 Over this period, gold’s long-term return was comparable to stocks and higher than bonds. Gold has also outperformed other major asset classes over the past two decades (Chart 2).

This duality reflects the diverse sources of demand for gold and differentiates it from other investment assets. 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 luxury good, valued by consumers across the world. And it is a key component in electronics. These diverse sources of demand give gold a particular resilience: the potential to deliver solid returns in good times and in bad (Focus 2).

 

Chart 2: [US-ind] Gold has delivered positive returns over the long run, outperforming key asset classes

Average annual return of key global assets in US dollars*

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

*As of 31 December 2019. Computations in US dollars of total return indices for ICE 3-month Treasury, Bloomberg Barclays US Bond Aggregate, MSCI US, EAFE and EM indices, Bloomberg Commodity Index and spot for LBMA Gold Price PM.

 

Beating inflation, combating deflation

Gold is long considered a hedge against inflation and the data confirms this. The average annual return of 10% over the past 49 years, has outpaced the US consumer price index (CPI). 

Gold also protects investors against extreme inflation. In years when inflation was higher than 3% gold’s price increased 15% 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.7 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: [US-ind] Gold has historically rallied in periods of high inflation

Gold returns in US dollars as a function of annual inflation*

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

*Based on y-o-y changes of the LBMA Gold Price and US CPI between 1971 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.8 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: [US-ind] 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. 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 S&P 500 fell by 50% from December 2007 to February 2009. Gold by contrast held its own, rising 14% over the same period.9

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. Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, undervalued and possibly mispriced.

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 a luxury good. 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 (Chart 5), likely driven by a wealth-effect supporting gold consumer demand as well as demand from investors seeking protection against higher inflation expectations.

 

Chart 5: [US-ind] Gold’s correlation with stocks helps portfolio diversification in good and bad economic times

Correlation between gold and US stock 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 between the S&P 500 Index and: 1) the Bloomberg Commodity Index; and 2) the LBMA Gold Price PM since January 1971. The middle bar corresponds to the correlation between the S&P 500 and gold or commodities, respectively, conditional on the weekly return of the S&P 500 falling or rising by less than two standard deviations (or ‘s’). The bottom bar corresponds to the correlation conditional on S&P 500 weekly return falling by more than two standard deviations (or ‘s’) respectively, while the top bar corresponds to the S&P 500 weekly return increasing by more than two 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 US$3.7tn, with an additional US$900bn in open interest through derivatives traded on exchanges or the over-the-counter market.10

The gold market is also more liquid than several major financial markets, including German Bunds, euro/Yen and the Dow Jones Industrial Average, while trading volumes are similar to the S&P 500 (Chart 6). Gold’s trading volumes averaged US$145bn per day in 2019. During that period, over-the-counter spot and derivatives contracts accounted for US$78bn and gold futures traded US$65bn per day across various global exchanges. Gold-backed ETFs offer an additional source of liquidity, with the largest US-listed funds trading an average of US$2bn 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: [US-ind] Gold trades more than many other major financial assets

Average daily trading volumes in US dollars*

Sources: Bloomberg, Bank for International Settlements, UK Debt Management Office (DMO), Germany Finance Agency, Japan Securities Dealers Association, London Bullion Market Association, 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 five, 10 and 20 years underlines gold’s positive impact on an investor portfolio. For example, an average US investment portfolio would have achieved higher risk-adjusted returns if 2.5%, 5% or 10% of the portfolio were allocated to gold over the past decade (Chart 7). The positive impact has been particularly marked since the global financial crisis.

In addition to historical back-testing, a more comprehensive optimisation analysis based on New Frontier Advisors Resampled EfficiencyTM shows that US dollar-based investors can benefit from a material enhancement in performance if they allocate between 2% and 10% of a well-diversified portfolio to gold (Chart 8a).11

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,12 and for investors who hold alternative assets, such as commodities (Focus 3), real estate, private equity and hedge funds.13

 

Chart 7: [US -ind] Adding gold over the past decade would have increased risk-adjusted returns of a hypothetical average US investment portfolio

Performance of a hypothetical average US portfolio with and without gold*

Sources: AAII, Bloomberg, ICE Benchmark Administration, Morgan Stanley, US Trust, World Gold Council; Disclaimer

*Based on performance between 31 December 2009 and 31 December 2019. The hypothetical average US portfolio is based on the American Association of Individual Investors average allocations over the past twenty years, along with a combination of the 2019 US Trust High Net Worth allocation survey, and the 2020 MS GIC Capital Markets Update paper. It includes annually-rebalanced total returns of a 47% allocation to stocks (23% MSCI USA Net Total Return, 18% MSCI ACWI ex US, 6% MSCI Emerging Net Total Return), 36% allocation to fixed income (26% Barclays US Aggregate, 3% Barclays Global Aggregate ex US, 1% JPMorgan EM Global Bond Index and 6% short-term Treasuries), and 17% alternative assets (3% FTSE REITs Index, 11% HFRI Hedge Fund Index, and 3% Bloomberg Commodity 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.

 

Chart 8: Gold can significantly improve risk-adjusted returns of hypothetical portfolios across various levels of risk

Chart 8a: [US -ind] Gold can significantly improve risk-adjusted returns of hypothetical portfolios across various levels of risk

(8a) Optimal allocations that deliver the highest risk-adjusted returns for various hypothetical portfolio types*

Sources: World Gold Council; Disclaimer

* Optimisation analysis based on New Frontier Advisors “Resampled Efficiency” using monthly returns from January 1989 to December 2019. Data includes total return indices of ICE 3-month Treasury Index, Bloomberg Barclays US Bond Aggregate Index, Bloomberg Barclays Global Bond Aggregate ex US Index, MSCI US, EAFE and EM indices, FTSE NAREIT Equity REITs Index, and Bloomberg Commodity Index, as well as spot returns of LBMA Gold Price PM, all in US dollars. Each hypothetical portfolio type reflects a different allocation to cash, bonds, equities, alternative assets and gold. The labels “Conservative”, “Moderate” and “Aggressive” reflect commonly accepted compositions of hypothetical portfolio types based on surveys from organisations such as the American Association of Individual Investors among others. For example, the “Moderate portfolio allocation” holds approximately 28% in cash and bonds, 42% in stocks, and 30% in REITs, hedge funds, private equity, commodities and gold. .  For each given hypothetical portfolio type in Chart 8a, a given color bar section represents the optimal allocation for a corresponding asset class. The portfolio mix corresponds to the allocations to that delivered the highest risk-adjusted return for the total portfolio based on the optimisation analysis. The gold bars in Chart 8b represent the range of all possible optimal gold allocations for each hypothetical portfolio type, based on variations to the allocation of other assets that would still be fall under a “Conservative”, “Moderate” and “Aggressive” composition, respectively. Generally, higher exposure to equities and similar assets resulted in higher optimal allocations for gold, likely to counterbalance the additional risk incurred. For more information on “Resampled Efficiency”, see Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008.

 

Chart 8b: [US -ind] Gold can significantly improve risk-adjusted returns of hypothetical portfolios across various levels of risk

(8b) Range of possible optimal gold allocations for varying allocations to other assets within a given portfolio type*

* Optimisation analysis based on New Frontier Advisors “Resampled Efficiency” using monthly returns from January 1989 to December 2019. Data includes total return indices of ICE 3-month Treasury Index, Bloomberg Barclays US Bond Aggregate Index, Bloomberg Barclays Global Bond Aggregate ex US Index, MSCI US, EAFE and EM indices, FTSE NAREIT Equity REITs Index, and Bloomberg Commodity Index, as well as spot returns of LBMA Gold Price PM, all in US dollars. Each hypothetical portfolio type reflects a different allocation to cash, bonds, equities, alternative assets and gold. The labels “Conservative”, “Moderate” and “Aggressive” reflect commonly accepted compositions of hypothetical portfolio types based on surveys from organisations such as the American Association of Individual Investors among others. For example, the “Moderate portfolio allocation” holds approximately 28% in cash and bonds, 42% in stocks, and 30% in REITs, hedge funds, private equity, commodities and gold. .  For each given hypothetical portfolio type in Chart 8a, a given color bar section represents the optimal allocation for a corresponding asset class. The portfolio mix corresponds to the allocations to that delivered the highest risk-adjusted return for the total portfolio based on the optimisation analysis. The gold bars in Chart 8b represent the range of all possible optimal gold allocations for each hypothetical portfolio type, based on variations to the allocation of other assets that would still be fall under a “Conservative”, “Moderate” and “Aggressive” composition, respectively. Generally, higher exposure to equities and similar assets resulted in higher optimal allocations for gold, likely to counterbalance the additional risk incurred. For more information on “Resampled Efficiency”, see Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008.

 

Chart 9: Gold has outperformed broad-based commodity indices and individual commodities

Chart 9: [US-ind] 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 from December 1999 to December 2019. Indices include: S&P GS Energy Index, S&P GS Precious Metals Index, S&P GS Industrial Metals Index, S&P GS Non-Precious Metals Index, LBMA Gold Price PM (US$/oz).

 

Conclusion

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 investment portfolios worldwide.

Gold’s unique attributes as a scarce, highly liquid and un-correlated asset prove that it can act as a genuine diversifier over the long term. 

Gold’s position as an investment and a luxury good has allowed it to deliver average returns of approximately 10% for nearly five decades, comparable to stocks and more than bonds and commodities (see Chart 2).

Gold’s traditional role as a safe-haven asset means it comes into its own 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 the current environment of high political and economic uncertainty, historically low interest rates and concerns surrounding stock and bond markets (see 2020 Gold Outlook).

Overall, extensive analysis suggests that adding between 2% and 10% of gold to a US-dollar based portfolio will make a tangible improvement to performance and boost risk-adjusted returns on a sustainable, long-term basis (see Chart 7).

 

Footnotes

1See (Chart 7) for more details behind the composition of the hypothetical average US investment portfolio. In addition, refer to important disclaimers and disclosures at the end of this report.

2Willis Towers Watson, Global Pension Assets Study 2019, February 2020  and Global Alternatives Survey 2017, July 2017. www.willistowerswatson.com/en-US/News/2020/02/global-pension-assets-on-the-rise

32019 US Trust High Net Worth allocation survey.

4As of 31 December 2019.

5During 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.

6Qaurum is a web-based quantitative tool that helps investors intuitively understand the drivers of gold’s performance that can be explained by four broad sets of drivers.

7Oxford Economics, The impact of inflation and deflation on the case for gold, July 2011.

8See the demand and supply section at Goldhub.com.

9Based on the S&P 500 Index and the LBMA Gold Price PM from the end of December 2007 to the end of February 2009.

10See the holders and trends section at Goldhub.com.

11Analysis 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.

12Gold as a tactical inflation hedge and long-term strategic asset, July 2009.

13How gold improves alternative asset performance, Gold Investor, Volume 6, June 2014.

14See: Gold: the most effective commodity investment, September 2019, and Gold: metal by design, currency by nature, Gold Investor, Volume 6, June 2014.

Important disclaimers and disclosures

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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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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.