Australia edition

Sectors: Investment

What makes gold a strategic asset?

Gold benefits from diverse sources of demand: as an investment, a reserve asset, jewellery, and a technology component.  It is highly liquid, no one’s liability, carries no credit risk, and is scarce, historically preserving its value over time.

 

Gold can enhance a portfolio in four key ways:

Returns

Diversification

Liquidity

Portfolio performance

 

Extraordinary times with extraordinary opportunities 

2020 posed unprecedented challenges to investors as the first global pandemic in a century ravaged the world economically and socially.

COVID-19 significantly increased uncertainty by compounding existing risks and creating new ones. The rollout of new vaccines at the end of last year fuelled optimism that the worst was over. Yet the pandemic and the ensuing policy response from governments will likely have unintended consequences for, and create structural changes to, asset allocation strategies. 

Global central banks have effectively taken interest rates to zero, driving nearly all sovereign debt to negative real yields. With less opportunity for yield across fixed income assets – especially those of shorter duration or higher quality – investors will likely continue to shift exposure to riskier assets. This has pushed many global stock markets to extreme levels on numerous valuation metrics and – importantly - has also served to increase the risk profile of most investment portfolios.

Additionally, many countries have made it clear they will continue to enact sizeable fiscal policy measures to tackle the economic impact of COVID-19, along with expanding budget deficits and balance sheets. 

We believe these actions - in combination with the current environment have made gold increasingly relevant as a strategic asset. Not only could investors benefit from gold’s role as a diversifier amid ballooning budget deficits, inflationary pressures, and potential market corrections from already high equity valuations, but they may also see additional support as gold consumption will likely benefit from the nascent economic recovery, especially in emerging markets  (see 2021 Gold Outlook).

ESG considerations

Over recent years, investors have increasingly looked to integrate environmental, social and governance (ESG) considerations as part of their investment process. For example, 89% of European investors now take ESG factors into account when they make investment decisions.2 This increased emphasis on ESG reflects increasing pressure for businesses to actively manage ESG risks. It also emphasises that good ESG performance could lead to better long-term financial performance.3 This shift towards a greater integration has important implications for gold, which needs to demonstrate that it is produced and sourced responsibly, as well as the role that gold can play in supporting ESG objectives within a portfolio (Focus 2: Gold as an ESG investment).4

The increased relevance of gold

Institutional investors5 have embraced alternatives to traditional stocks and bonds in pursuit of diversification and higher risk-adjusted returns. The share of non-traditional assets, such as hedge funds, private equity funds or commodities, among global pension funds increased from 7% in 1998 to 23% in 2019 – this figure is 30% in the US (Chart 1).6

Gold allocations have been recipients of this shift. Investors increasingly recognise gold as a mainstream investment; global investment demand has grown by an average of 15% per year since 2001 and the gold price has increased almost five-fold over the same period.7

 

Chart 1: Alternative investments including gold have become a key portfolio strategy

Alternative investments including gold have become a key portfolio strategy

Institutional investors continue to add alternative investments, including gold, to their portfolios*

Alternative investments including gold have become a key portfolio strategy
Institutional investors continue to add alternative investments, including gold, to their portfolios*
Sources: World Gold Council, Willis Towers Watson; Disclaimer *As of December 2020. See Willis Towers Watson, Global Pension Asset Study 2021.

Sources: World Gold Council, Willis Towers Watson; Disclaimer

 

 

Gold performance has been strong in recent decades, supported by key structural changes

 

Gold performance has been strong in recent decades, supported by key structural changes

Gold performance has been strong in recent decades, supported by key structural changes
Source: World Gold Council

Sources: World Gold Council; Disclaimer

 

Gold’s strategic role

Our analysis shows gold is a clear complement to equities, 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

Investors have long consider gold a beneficial asset during periods of uncertainty. Historically, it has generated long-term positive returns in both good and bad economic times. Looking back almost half a century, the price of gold in US dollars has increased by an average of nearly 11% per year since 19719 when the gold standard collapsed.10 Over this period, gold’s long-term return is comparable to equities and higher than bonds.11 Gold has also outperformed many other major asset classes over the past five, 10 and 20 years (Chart 2 and Chart 3). 

This duality reflects the diverse sources of demand for gold and differentiates it from other investment assets. Gold is often used to protect and enhance wealth over the long term as it is no one’s liability, and it operates as a means of exchange due to its global recognition. 

Gold is also in demand via the jewellery market, valued by consumers across the world. And it is a key component in electronics.12 These diverse sources of demand give gold a particular resilience: the potential to deliver solid returns in various market conditions (Chart 7, p6).

 

Chart 2: Gold has outperformed most broad-based portfolio components over the past two decades*

Gold has outperformed most broad-based portfolio components over the past two decades*

Average annual return of key global assets in Australian dollars*

Gold has outperformed most broad-based portfolio components over the past two decades*
Average annual return of key global assets in Australian dollars*
*Returns from 31 December 2000 to 31 December 2020. In Australian dollars of total return indices for S&P/ASX 200, Bloomberg Aus Bond Bank Bill Index, Bloomberg AusBond Govt 1+ Yr Index, S&P/ASX 200 A-REIT (Sector) and Bloomberg Commodity Index. No 20 year data available for Bloomberg Barclays Australian Corporate Bond Index. On Goldhub.com see: Gold returns. Sources: Bloomberg, ICE Benchmark Administration, World Gold Council

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

*Returns from 31 December 2000 to 31 December 2020. In Australian dollars of total return indices for S&P/ASX 200, Bloomberg Aus Bond Bank Bill Index, Bloomberg AusBond Govt 1+ Yr Index, S&P/ASX 200 A-REIT (Sector) and Bloomberg Commodity Index. No 20 year data available for Bloomberg Barclays Australian Corporate Bond Index.

On Goldhub.com see: Gold returns..

 

Chart 3: Gold has performed well over the past decade, despite the strong performance of risk-assets

Gold has performed well over the past decade, despite the strong performance of risk-assets

Average annual return over the past five and 10 years*

Gold has performed well over the past decade, despite the strong performance of risk-assets
Average annual return over the past five and 10 years*
*Returns in Australian dollars from 31 December 2010 to 31 December 2020. See Chart 2 for respective indices. On Goldhub.com see: Gold returns. Sources: Bloomberg, ICE Benchmark Administration, World Gold Council

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

*Returns in Australian dollars from 31 December 2010 to 31 December 2020. See Chart 2 for respective indices.

On Goldhub.com see: Gold returns.
.

 

Beating inflation, combating deflation

Gold has long been considered a hedge against inflation and the data confirms this. The average annual return of 11% in US dollars over the past 50 years, has outpaced the Australian and world consumer price indices (CPI).13 

Gold also protects investors against high and extreme inflation. In years when inflation was higher than 3%, gold’s price increased 20% per year on average (Chart 4). Over the long term, therefore, gold has not just preserved capital but helped it grow. 

Research also shows that gold should do well in periods of deflation.14 Such periods are characterised by low interest rates, reduced consumption and investment, and financial stress, all of which tend to foster gold demand.

 

Chart 4: Gold historically rallies in periods of high inflation, outperforming broad-based commodities

Gold historically rallies in periods of high inflation, outperforming broad-based commodities

Gold and commodity returns in Australian dollars as a function of annual inflation*

Gold historically rallies in periods of high inflation, outperforming broad-based commodities
Gold and commodity returns in Australian dollars as a function of annual inflation*
*Based on y-o-y changes for the LBMA Gold Price PM, Bloomberg Commodity Index and Australian CPI between January 1971 and 31 December 2020 in Australian dollars, based on available data. Sources: Bloomberg, ICE Benchmark Administration, World Gold Council

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

*Based on y-o-y changes for the LBMA Gold Price PM, Bloomberg Commodity Index and Australian CPI between January 1971 and 31 December 2020 in Australian dollars, based on available data. 

 

Outperforming fiat currencies

Investor demand has been boosted by persistently low interest rates and concerns about the outlook for the dollar, which affect the perceived opportunity cost of holding gold.

Historically, major currencies were pegged to gold. That changed with the unravelling of the US gold standard in 1971 and the eventual collapse of the Bretton Woods system.15 Since then, with few exceptions, gold has significantly outperformed all major currencies and commodities as a means of exchange (Chart 5). This outperformance was particularly marked immediately after the end of the gold standard. A key factor behind this robust performance is that the supply growth of gold has changed little over time – increasing by approximately 1.4% per year over the past 20 years.16

By contrast, fiat money can be printed in unlimited quantities to support monetary policy, as exemplified by the quantitative easing measures in the aftermath of the Global Financial Crisis (GFC).17 In recent years, the rapidly increasing global money supply and a low to negative rate environment have fostered an optimal environment for gold to outperform global sovereign debt, such as US treasuries and to track the global money supply (Chart 6 p6).

 

Chart 5: The purchasing power of major currencies and commodities has significantly eroded relative to gold

The purchasing power of major currencies and commodities has significantly eroded relative to gold

Value of currencies and broad commodities relative to gold (January 2000 = 100)*

The purchasing power of major currencies and commodities has significantly eroded relative to gold
Value of currencies and broad commodities relative to gold (January 2000 = 100)*
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council *As of 31 December 2020. Relative value between ‘gold’: LBMA Gold Price PM, ‘commodities’: Bloomberg Commodity Index, and major currencies since 2000. Value of commodities and currencies measured in ounces of gold and indexed to 100 in January 2000. On Goldhub.com see: Gold prices.

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

*As of 31 December 2020. Relative value between ‘gold’: LBMA Gold Price PM, ‘commodities’: Bloomberg Commodity Index, and major currencies since 2000. Value of commodities and currencies measured in ounces of gold and indexed to 100 in January 2000. 

On Goldhub.com see: Gold prices.

 

 

Chart 6: Gold prices have tracked the expansion of global money supply and outpaced T-bills over time

Gold prices have tracked the expansion of global money supply and outpaced T-bills over time

Global M2 growth, US 3m T-bill total return, gold price*

Gold prices have tracked the expansion of global money supply and outpaced T-bills over time
Global M2 growth, US 3m T-bill total return, gold price*
Sources: Bloomberg, ICE Benchmark Administration, Oxford Economics, World Gold Council *As of 31 December 2020. Data starts in 1973 due to data availability. Global M2 is first calculated by aggregating the available universe of individual country M2 in US dollars (excluding Venezuela due to data quality) as provided by Oxford Economics. The resulting aggregate is then re-based to 100 on January 1973. US 3m T-bill total returns constructed using cumulative returns based on 3-month US T-bill yields and also rebased to 100 on January 1973. Gold based on the LBMA Gold Price PM USD.

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

*As of 31 December 2020. Data starts in 1973 due to data availability. Global M2 is first calculated by aggregating the available universe of individual country M2 in US dollars (excluding Venezuela due to data quality) as provided by Oxford Economics. The resulting aggregate is then re-based to 100 on January 1973. US 3m T-bill total returns constructed using cumulative returns based on 3-month US T-bill yields and also rebased to 100 on January 1973. Gold based on the LBMA Gold Price PM USD.

 

Diversification that works

The benefits of diversification are widely acknowledged – but it is hard to find effective diversifiers. Many assets become 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 equities and other risk assets generally increases as these assets sell off (Chart 7). The GFC is a case in point. Equities and other risk assets tumbled in value, as did hedge funds, real estate and most commodities, which were long deemed portfolio diversifiers. Gold, by contrast, held its own and increased in price, rising 67% in Australian dollars from December 2007 to February 2009.18 And in the most recent sharp equity market pullbacks of 2018 and 2020, gold performance remained positive.19

This robust performance is perhaps not surprising. With few exceptions, gold has been particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses (Chart 8, p7). Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, or possibly mispriced. 

But gold’s correlation does not just work for investors during periods of turmoil. It can also deliver positive correlation with equities and other risk assets in positive markets, making gold a well-rounded efficient hedge (Chart 9, p7), (see Gold: an efficient hedge).

This dual benefit arises from gold’s dual nature: as both an investment and a consumer good (Chart 18, p15). As such, the long-term performance of gold is supported by income growth. Our analysis bears this out, showing that when equities rally strongly, their correlation to gold can increase. This is most likely driven by a wealth-effect supporting gold consumer demand, as well as demand from investors seeking protection against higher inflation expectations.

 

Chart 7: Gold has been more negatively correlated with equities in extreme market selloffs than commodities and US treasuries

Gold has been more negatively correlated with equities in extreme market selloffs than commodities and US treasuries

Correlation between gold, commodities and treasuries, and Australian equity returns in various environments of equity market performance since 2000*

Gold has been more negatively correlated with equities in extreme market selloffs than commodities and US treasuries
Correlation between gold, commodities and treasuries, and Australian equity returns in various environments of equity market performance since 2000*
*As of 31 December 2020. Correlations computed using daily returns based on the Gold in Australian dollars, the S&P/ASX200 Index and Bloomberg Commodity Index in Australia dollars since December 2000. The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on the ASX200 daily return falling by more than one standard deviation, while the bottom bar corresponds to the ASX200 daily return falling by more than two standard deviations. The standard deviation is based on the same daily returns over the full period. Source: On Goldhub.com: Gold correlation. Sources: Bloomberg, ICE Benchmark Administration, World Gold Council

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

*As of 31 December 2020. Correlations computed using daily returns based on the Gold in Australian dollars, the S&P/ASX200 Index and Bloomberg Commodity Index in Australia dollars since December 2000. The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on the ASX200 daily return falling by more than one standard deviation, while the bottom bar corresponds to the ASX200 daily return falling by more than two standard deviations. The standard deviation is based on the same daily returns over the full period.    

Source: On Goldhub.com: Gold correlation.

 

Chart 8: The gold price tends to increase in periods of systemic risk

The gold price tends to increase in periods of systemic risk

Australian equities, bonds and gold versus realised volatility*

The gold price tends to increase in periods of systemic risk
Australian equities, bonds and gold versus realised volatility*
*Returns in Australian dollars. Realised volatility is based on the annualised 30-day ASX volatility. Dates used: LTCM: 7/1998-10/1998; 2002 recession: 2/2002-3/2003; Global financial crisis:11/2007-3/2009; Sovereign debt crisis I: 4/2010-7/2010; Sovereign debt crisis II: 2/2001-10/2011; 2015 China deleveraging: 6/2015-2/2016; 2018 pullback: 8/2018-12/2018; 2020 pullback: 2/2020-3/2020. Sources: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*Returns in Australian dollars. Realised volatility is based on the annualised 30-day ASX volatility. Dates used: LTCM: 7/1998-10/1998; 2002 recession: 2/2002-3/2003; Global financial crisis:11/2007-3/2009; Sovereign debt crisis I: 4/2010-7/2010; Sovereign debt crisis II: 2/2001-10/2011; 2015 China deleveraging: 6/2015-2/2016; 2018 pullback: 8/2018-12/2018; 2020 pullback: 2/2020-3/2020.

Asset Performance during market
sell-off*
Performance during market
recovery*
  Average Median Average Median
Gold 16.3% 8.4% 6.1% 3.6%
Australian sov'gn bonds 6.9% 4.0% 6.3% 4.2%

*Average and median returns based off time horizons in Charts 8 and 9.
Source: Bloomberg, World Gold Council

 

Chart 9: Gold prices perform well following the period after a systemic selloff and its subsequent recovery

Gold prices perform well following the period after a systemic selloff and its subsequent recovery

Performance of gold and treasuries from the market trough (bottom) to the market recovery point (equity market levels before the systemic selloff)*

Gold prices perform well following the period after a systemic selloff and its subsequent recovery
Performance of gold and treasuries from the market trough (bottom) to the market recovery point (equity market levels before the systemic selloff)*
*Returns in Australian dollars. Dates based off end dates of Chart 8: LTCM: 10/1998-12/1998; 2002 recession: 3/2003-7/2004; Global financial crisis: 3/2009-1/2013; Sovereign debt crisis I: 5/2010 – 11/2010; Sovereign debt crisis II: 10/2011 – 2/2012; 2015 China deleveraging: 2/2016-2/2017; 2018 pullback: 12/2018-6/2019; 2020 pullback: 3/2020-7/2020 Sources: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*Returns in Australian dollars. Dates based off end dates of Chart 8: LTCM: 10/1998-12/1998; 2002 recession: 3/2003-7/2004; Global financial crisis: 3/2009-1/2013; Sovereign debt crisis I: 5/2010 – 11/2010; Sovereign debt crisis II: 10/2011 – 2/2012; 2015 China deleveraging: 2/2016-2/2017; 2018 pullback: 12/2018-6/2019; 2020 pullback: 3/2020-7/2020

 

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 A$6.2tn, with an additional A$1.5tn in open interest through derivatives traded on exchanges or the over-the-counter (OTC) market (Chart 16a p14).

The gold market is also more liquid than several major financial markets, including US T-bills, euro/yen and UK Gilts, while trading volumes are similar to those of the S&P 500 (Chart 10). Gold’s trading volumes averaged approximately A$238bn per day in 2020. During that period, OTC spot and derivatives contracts accounted for A$144bn and gold futures traded A$90bn per day across various global exchanges. Gold-backed ETFs (gold ETFs) offer an additional source of liquidity, with the largest US-listed funds trading an average of A$4.3bn per day (Chart 11).

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 financial stress, making it a much less volatile asset (Chart 12). 

 

Chart 10: Gold trades more than many other major financial assets

Gold trades more than many other major financial assets

One-year average trading volumes of a number of major assets in Australian dollars*

Gold trades more than many other major financial assets
One-year average trading volumes of various major assets in Australian dollars *
*Average daily volumes from 31 December 2010 to 31 December 2020, except for currencies that correspond to March 2019 volumes due to data availability. **Gold liquidity includes estimates of OTC transactions and published statistics on futures exchanges, and gold-backed exchange-traded products. On Goldhub.com see: Gold trading volumes. Sources: Bloomberg, Bank for International Settlements, UK Debt Management Office (DMO), Germany Finance Agency, Japan Securities Dealers Association, Nasdaq, World Gold Council

Sources: Bloomberg, Bank for International Settlements, UK Debt Management Office (DMO), Germany Finance Agency, Japan Securities Dealers Association, Nasdaq, World Gold Council; Disclaimer

*Average daily volumes from 31 December 2010 to 31 December 2020, except for currencies that correspond to March 2019 volumes due to data availability.
**Gold liquidity includes estimates of OTC transactions and published statistics on futures exchanges, and gold-backed exchange-traded products. 

On Goldhub.com see: Gold trading volumes.

 

Chart 11: Gold is liquid across key investment platforms

Gold is liquid across key investment platforms

Average daily trading volume by point of access in 2020*

 

Gold is liquid across key investment platforms
Average daily trading volume by point of access in 2020*
*Average daily trading volume from 1 January 2020 to 31 December 2020 Gold liquidity includes estimates of over-the-counter (OTC) transactions and published statistics on futures exchanges, and gold-backed exchange-traded products. For more information, see Gold trading volumes on Goldhub.com. Sources: Bloomberg, Nasdaq, World Gold Council

Sources: Bloomberg, Nasdaq, World Gold Council; Disclaimer

*Average daily trading volume from 1 January 2020 to 31 December 2020
Gold liquidity includes estimates of over-the-counter (OTC) transactions and published statistics on futures exchanges, and gold-backed exchange-traded products. For more information, see Gold trading volumes on Goldhub.com.

 

 

Chart 12: Gold has been less volatile than many equity indices, alternatives and commodities because of its scale, liquidity and diverse sources of demand

Gold has been less volatile than many equity indices, alternatives and commodities because of its scale, liquidity and diverse sources of demand

Average daily volatility of several major assets since 2000*

Gold has been less volatile than many equity indices, alternatives and commodities because of its scale, liquidity and diverse sources of demand
Average daily volatility of several major assets since 2000*
*Annualised volatility is computed based on daily returns in Australian dollars between 31 December 2000 and 31 December 2020. Computations in Australian Dollar Spot of total return indices for S&P 500 INDEX, MSCI Daily TR Gross EM USD, MSCI AC World Daily TR Gross USD, LBMA Gold Price PM USD, Bloomberg Commodity Index Total Return, LBMA Silver Price - Price/USD, Bloomberg WTI Crude Oil Subindex Total Return, Bloomberg Barclays Global-Aggregate Total Return Index Value Unhedged USD, S&P GSCI Copper Official Close Index TR, S&P GSCI Platinum Index TR ,S&P/ASX 200, MSCI AC ASEAN USD Net, Bloomberg Barclays Australian Corporate Total Return Index Value Unhedged USD. On Goldhub.com see: Gold volatility. Sources: Bloomberg, CBOE, COMEX , World Gold Council

Sources: Bloomberg, CBOE, COMEX , World Gold Council; Disclaimer

*Annualised volatility is computed based on daily returns in Australian dollars between 31 December 2000 and 31 December 2020. Computations in Australian Dollar Spot of total return indices for S&P 500 INDEX, MSCI Daily TR Gross EM USD, MSCI AC World Daily TR Gross USD, LBMA Gold Price PM USD, Bloomberg Commodity Index Total Return, LBMA Silver Price - Price/USD, Bloomberg WTI Crude Oil Subindex Total Return, Bloomberg Barclays Global-Aggregate Total Return Index Value Unhedged USD, S&P GSCI Copper Official Close Index TR, S&P GSCI Platinum Index TR ,S&P/ASX 200, MSCI AC ASEAN USD Net, Bloomberg Barclays Australian Corporate Total Return Index Value Unhedged USD.

On Goldhub.com see: Gold volatility.
 

Enhanced portfolio performance

Long-term returns, liquidity and effective diversification all benefit overall portfolio performance. In combination, they suggest that the addition of gold can materially enhance a portfolio’s risk-adjusted returns. 

Our analysis of investment performance over the past one, five, 10 and 15 years underlines gold’s positive impact on an institutional portfolio. It shows that the average Australian superfund portfolio would have achieved higher risk-adjusted returns and lower drawdowns if 2%, 4% or 10% were allocated to gold (Chart 13 and Table 1). This positive impact has been particularly marked since the GFC.

In addition to traditional back-testing, a more robust optimisation analysis based on ‘re-sampled efficiency’20 suggests that an allocation to gold may result in a material enhancement to portfolio performance. For example, gold allocations between 2% and 10% across well-diversified Australian dollar-based portfolios with varying levels of risk could result in higher risk-adjusted returns (Chart 14, p10). 

The ‘optimal’ amount of gold varies according to individual asset allocation decisions. Broadly speaking, the analysis suggests that 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 14 p10).

Our analysis also indicates that gold’s optimal weight in these hypothetical portfolios can be statistically significant even if investors assume an annual return for gold of between 2% and 4% – well below long-term historical performance. This works equally for investors who already hold other inflation-hedging assets, such as inflation-linked bonds,21 and for investors who hold alternative assets, such as real estate, private equity and hedge funds.22

 

Chart 13: Adding gold over the past twenty years would have increased risk-adjusted returns of a hypothetical Australian superfund portfolio

Adding gold over the past twenty years would have increased risk-adjusted returns of a hypothetical Australian superfund portfolio

Performance of a hypothetical average Australian superfund portfolio with and without gold*

Adding gold over the past twenty years would have increased risk-adjusted returns of a hypothetical Australian superfund portfolio
Performance of a hypothetical average Australian superfund portfolio with and without gold*
*Based on monthly total returns from 31 December 2010 and 31 December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s superannuation asset allocation update in 2020. It includes annually-rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% to Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to Bloomberg AusBond Bank Bill Index and 17% alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index). Sources: Australian Prudential Regulation Authority, Bloomberg, ICE Benchmark Administration, World Gold Council

Sources: Australian Prudential Regulation Authority, Bloomberg, ICE Benchmark Administration, World Gold Council; Disclaimer

*Based on monthly total returns from 31 December 2010 and 31 December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s superannuation asset allocation update in 2020. It includes annually-rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% to Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to Bloomberg AusBond Bank Bill Index and 17% alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).

 

Table 1: Gold would have increased risk-adjusted returns while reducing portfolio volatility and drawdowns

Comparison of a hypothetical Australian superfund portfolio and an equivalent portfolio with 5% gold over the past one, five, 10 and 15 years based on Australian dollar returns*

  15-year 10-year 5-year 1-year
  No gold 5% gold No gold 5% gold No gold 5% gold No gold 5% gold
Annualised return 4.8% 5.0% 7.2% 7.1% 4.8% 5.0% 7.2% 7.1%
Annualised volatility 6.6% 6.0% 6.1% 5.7% 6.6% 6.0% 6.1% 5.7%
Risk-adjusted returns 0.73 0.84 1.18 1.25 0.73 0.84 1.18 1.25
Maximum drawdown -20.5% -11.0% -11.0% -9.3% -11.0%- -9.3% -11.0% -9.3%

* Based on performance between 31 December 2005 and 31 December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s superannuation asset allocation update in 2020.

Source: Bloomberg, ICE Benchmark Administration, Australian Prudential Regulation Authority, World Gold Council

 

Chart 14: Gold could significantly improve risk-adjusted portfolio returns across various levels of risk

Gold could significantly improve risk-adjusted portfolio returns across various levels of risk

(a) Long-run optimal allocations based on asset mix*

Gold could significantly improve risk-adjusted portfolio returns across various levels of risk
(a) Long-run optimal allocations based on asset mix*
*Based on monthly data between December 2005 and December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s average superannuation asset allocation in 2020. It includes annually-rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% to Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to Bloomberg AusBond Bank Bill Index and 17% alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).. Each hypothetical portfolio composition reflects a percentage in stock (“Eqty”), alternative assets (“Alts”), cash and bonds (“FI”). For example: ‘Average pension allocation’ is a portfolio with 34% in stocks, 17% in hedge funds, private equity real estates and infrastructure, and 43% in cash and bonds. 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. Sources: World Gold Council

Sources: World Gold Council; Disclaimer

Based on monthly data between December 2005 and December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s average superannuation asset allocation in 2020. It includes annually-rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% to Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to Bloomberg AusBond Bank Bill Index and 17% alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).. Each hypothetical portfolio composition reflects a percentage in stock (“Eqty”), alternative assets (“Alts”), cash and bonds (“FI”). For example: ‘Average pension allocation’ is a portfolio with 34% in stocks, 17% in hedge funds, private equity real estates and infrastructure, and 43% in cash and bonds. 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.

 

Gold could significantly improve risk-adjusted portfolio returns across various levels of risk

(b) Range of gold allocations and the allocation that could deliver the maximum risk-adjusted return for each hypothetical portfolio mix*

Gold could significantly improve risk-adjusted portfolio returns across various levels of risk
(b) Range of gold allocations and the allocation that could deliver the maximum risk-adjusted return for each hypothetical portfolio mix*
*Based on monthly data between December 2005 and December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s average superannuation asset allocation in 2020. It includes annually-rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% to Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to Bloomberg AusBond Bank Bill Index and 17% alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).. Each hypothetical portfolio composition reflects a percentage in stock (“Eqty”), alternative assets (“Alts”), cash and bonds (“FI”). For example: ‘Average pension allocation’ is a portfolio with 34% in stocks, 17% in hedge funds, private equity real estates and infrastructure, and 43% in cash and bonds. 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. Sources: World Gold Council

Sources: World Gold Council; Disclaimer

*Based on monthly data between December 2005 and December 2020. The hypothetical average Australian superannuation fund portfolio is based on the Australian Prudential Regulation Authority’s average superannuation asset allocation in 2020. It includes annually-rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% to Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to Bloomberg AusBond Bank Bill Index and 17% alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).. Each hypothetical portfolio composition reflects a percentage in stock (“Eqty”), alternative assets (“Alts”), cash and bonds (“FI”). For example: ‘Average pension allocation’ is a portfolio with 34% in stocks, 17% in hedge funds, private equity real estates and infrastructure, and 43% in cash and bonds. 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

Perceptions of gold have changed substantially over the past two decades, reflecting increased wealth in the East and a growing worldwide appreciation of gold’s role within an institutional investment portfolio. 

Gold’s unique attributes as a scarce, highly liquid, and un-correlated asset demonstrate that it can act as a diversifier over the long term. Gold’s position as an investment and a luxury good has allowed it to deliver average returns of nearly 11% over the past 50 years, comparable to equities and more than bonds and commodities.26, 27 

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 continue, reflecting ongoing political and economic uncertainty, persistently low interest rates and economic concerns surrounding equity and bond markets. 

Overall, extensive analysis suggests that adding between 7% and 12% of gold to a Australian-based fund can make a tangible improvement to performance and boost risk-adjusted returns on a sustainable, long-term basis.29 

 

The strategic case for gold in Australia

Australia is on track for a swift recovery from its first recession in 30 years. In Q3 2020 the economy rebounded faster than expected (3.3%), prompting the OECD to upgrade its full-year 2020 forecast to a contraction of 3.8%, and its 2021 forecast to a growth of 3.2%.30 Competent management of the COVID-19 pandemic, along with substantial fiscal and monetary support, have boosted confidence, supported employment and aided the recovery in household expenditure. Despite further tailwinds from possible reopening of borders and distribution of vaccines beginning in Q1 2021, risks and challenges remain. 

The economy is not out of the woods

The global economic outlook remains uncertain as COVID-19 infections soar; potential vaccine rollout problems and the possibility of virus mutations remain. Australia’s economic recovery has been uneven due to region- and industry-specific restrictions and recovery in tourism and education exports is slow while accumulated job losses in the service industry sector are high. Fiscal support and job retention programmes planned for H2 2021 would also create headwinds for GDP growth.31

High household debt remains a vulnerable spot in the economy

While low debt servicing costs and rising property prices have thus far mitigated the drag from high household debt, levels of debt remain near historical highs.32 Household spending is exposed to the risk of a negative wealth effect should property prices fall – especially if impacted by declining immigration, slower population growth and weakened rental markets. Meanwhile, wage growth is sluggish and unemployment expected to be sticky.33 High household debt could be a factor once pent-up demand has run its course and savings return to pre-COVID-19 levels. Also, a possible reflation trend in the latter part of the year could see debt servicing costs inch higher, impacting asset values and disposable income. 

Tensions with China

The impact of tariffs imposed by China on Australian exports has thus far been minimal. Affected exports account for just 0.3% of GDP34 and are overshadowed by record levels of iron ore exports, which have soared due to infrastructure spending by China and a lack of alternative sources of supply. While the trade balance with China remains at a healthy surplus, any escalation in tensions could derail Australia’s economic recovery. China could increase its list of exports subjected to tariffs, as well as its import bans, with wheat seen as the potential next target.35 China could also slow purchases or enact temporary bans on iron ore imports once demand returns to normal or stockpiles reach satisfactory levels. Iron ore port inventories currently sit at 124.5m metric tonnes; already well above the average levels seen from 2015-2019.36 According to Goldman Sachs, a ban on iron ore could cut GDP growth by 2% over 12 months, widen the current account deficit to 2% of GDP and the budget deficit to 0.6% of GDP.37 Although unlikely, given that China depends on Australia for more than 60% of its iron ore imports,38 the threat of a twin deficit could impact the Australian dollar well before such drastic measures take place. 

The role of gold 

Australian consumers have long recognised the benefits of gold. Per capita demand of physical gold is higher than most Western developed countries and, within Asia, second only to Hong Kong and Singapore.39 However, institutional and retail investors stand to benefit from allocating a portion of their portfolios to gold. Gold offers an attractive source of returns amidst prevailing ultra-low interest rate environments (Figure 1). After six interest rate cuts in two years, the Australian cash rate target is now 0.1%, the lowest on record. This has impacted the returns of superannuation funds, which typically allocate more than 20% of their portfolios to domestic and international fixed income.40

 

Figure 1: Average superannuation returns have fallen in tandem with interest rates

Average superannuation returns have fallen in tandem with interest rates

Average superannuation returns have fallen in tandem with interest rates
*As of 31 December 2020. Superannuation returns consider the average returns of 150+ super funds. Gold price is the annual average price of gold in Australia dollars. Sources: Association of Superannuation Funds of Australia (ASFA), Reserve Bank of Australia

Sources: Association of Superannuation Funds of Australia (ASFA), Reserve Bank of Australia; Disclaimer

*As of 31 December 2020. Superannuation returns consider the average returns of 150+ super funds. Gold price is the annual average price of gold in Australia dollars

 

The low rate environment

A shift to a low interest rate regime 

Interest rates in Australia had historically been high relative to other major economies in the world. Driven by robust economic growth, rising property prices and an average annual inflation rate in excess of the RBA’s 2-3% target, benchmark interest rates averaged 5% annually between 2000 and 2010 and were substantially higher than interest rates in comparable economies. In recent years, the Australian benchmark interest rate has been falling as economic activity in its largest trading partner, China, slows. With Australia’s headline inflation also declining and eventually falling below the RBA’s 2-3% target range, the need to maintain a high interest rate regime diminished. Between 2011 and 2020, the RBA made 15 rate cuts to combat slowing economic growth and the decline in inflation. The advent of the COVID-19 pandemic in 2020 necessitated further cuts and the benchmark interest rate was reduced to a record low of 0.1%. 

 

Figure 2: The price of gold has been supported by falling real treasury yield in Australia

The price of gold has been supported by falling real treasury yield in Australia

The price of gold has been supported by falling real treasury yield in Australia
Sources: ICE Benchmark Administration, Reserve Bank of Australia, World Gold Council

Sources: ICE Benchmark Administration, Reserve Bank of Australia, World Gold Council; Disclaimer

 

The relevance of gold

Historical data shows that gold returns in Australian dollars averaged 4% during periods with rate cuts. Between 2011 and 2020, a 4.65 percentage point reduction in the benchmark interest rate prompted the price of gold in Australian dollars to surge by 84% and the gold holdings of Australia-listed gold-backed ETFs to triple.

With inflation expected to remain subdued in years to come, the benchmark interest rate is likely to stay low. In this environment, gold can prove a useful addition to the portfolios of superannuation funds.
 
Gold, which tends to perform well in a low interest rate environment, is a useful addition to a portfolio (Figure 2). With its safe-haven qualities and diversification benefits, gold also plays an increasingly important role as a safe-haven anchor in portfolios that are pushed to take on more risk amidst the low-yield environment (Figure 3). 

There is also huge potential for further gold investment demand in Australia. Total superannuation assets currently sit at AUD2.9tn and are expected to grow to AUD8.5tn by 2035.41 Self-managed super funds (SMSF), which are privately-run super funds that allow allocation to gold, already account for 25% of total assets and are expected to grow in tandem with total assets.42 As superannuation assets increase, investment demand for gold is likely to also increase, especially if interest rates stay low and the local housing market softens. 

Gold is also well placed to help investors navigate growth risks ahead. Gold in Australian dollars has been shown to perform well during periods of currency weakness, for example those arising from trade tensions or a slowdown in economic activity. This is due to the persistent negative correlation between the price of gold in Australian dollars and the AUD/USD exchange rate, which allows gold to serve as a hedge against currency depreciation that may be caused by a decline in commodity prices or rising trade tensions with China. 

 

Figure 3: AUDUSD weakness has typically been met by XAUAUD strength

AUDUSD weakness has typically been met by XAUAUD strength

Correlation between AUDUSD and XAUAUD in various environments of AUDUSD’s performance*

AUDUSD weakness has typically been met by XAUAUD strength
Correlation between AUDUSD and XAUAUD in various environments of AUDUSD’s performance*
*As of December 2020. Correlations computed using daily returns based on the AUDUSD and XAUAUD since December 2010. The middle bar corresponds to the unconditional correlation over the full period. The bottom bar corresponds to the correlation conditional on the AUDUSD daily return increasing by more than one standard deviations, while the top bar corresponds to the AUDUSD daily return decreasing by more than one standard deviations. The standard deviation is based on the same daily returns over the full period. Sources: Bloomberg, World Gold Council

Sources: Bloomberg, World Gold Council; Disclaimer

*As of December 2020. Correlations computed using daily returns based on the AUDUSD and XAUAUD since December 2010.
The middle bar corresponds to the unconditional correlation over the full period. The bottom bar corresponds to the correlation conditional on the AUDUSD daily return increasing by more than one standard deviations, while the top bar corresponds to the AUDUSD daily return decreasing by more than one standard deviations. The standard deviation is based on the same daily returns over the full period.

1Oxford Economics is a leader in global forecasting and quantitative analysis and a specialist in modelling. Visit QaurumSM for important disclosures about Oxford Economics’ data, as well as a detailed description of the available scenarios; the assumptions underlying and data used for each scenario; and its respective hypothetical impact on gold demand, supply and performance.

2Mercer European Asset Allocation Insights 2020, August 2020

3Refinitiv, How do ESG scores relate to financial returns, August 2020.

4Gold and climate change: Current and future impacts, October 2019

5An institutional investor holds and/or manages assets for clients in larger, pooled portfolios often represented as mutual funds, banks, brokerages, hedge funds, etc.

6Willis Towers Watson, Global Pension Assets Study 2021, February 2021 and Global Alternatives Survey 2017, July 2017.

7Returns in Australian dollars from 31 December 2000 to 31 December 2020.

8See Chart 13 on p9 for more details behind the composition of the hypothetical Australian superannuation fund portfolio. Based on 2005 – 2020. In addition, refer to important disclaimers and disclosures at the end of this report.

9January 1971 – December 2020.

10During 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.

11For other return metrics and performance see Appendix II on page 17.

12See Chart 18a, on page 15.

13Based on average annual CPI changes for Australia and world as measured by the IMF from December 1988 – December 2020. 

14Oxford Economics, The impact of inflation and deflation on the case for gold, July 2011.

15Ibid footnote 10.

16From December 2000 – December 2020. See the Demand and Supply section at Goldhub.com.

17For more information please see The impact of monetary policy on gold and It may be time to replace bonds with gold.

18Based on the LBMA Gold Price PM from 1 December 2007 to 27 February 2009.

19Based on the LBMA Gold Price PM from 1 October 2018 to 27 December 2018 and from 31 January 2020 to 31 March 2020.

20Re-sampled efficiency is a 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.

21Gold as a tactical inflation hedge and long-term strategic asset, July 2009, July 2009.

22Enhancing the performance of alternatives with gold, February 2018.

23See: Gold: the most effective commodity investment, and Gold: metal by design, currency by nature, Gold Investor, Volume 6, June 2014.

24For more information on the gold weight increases see: Major commodity indices will increase gold weightings for a second year in a row.

25Gold: the most effective commodity investment, September 2019.

26Average annualised returns in US dollars from January 1971 to December 2020.

27See Chart 22 p17.

28The Greenhouse Gas Protocol, Ecoinvent database. Please see Gold and climate change: Current and future impacts and Gold and climate change: An introduction.

29See Chart 13, p9

30OECD Economic Outlook, Vol 2020 Issue 2: Preliminary Version.

31Ibid 1.

32Reserve Bank of Australia (RBA).

33As of Nov 2020, the RBA expects unemployment to be at 6% by end 2022.

34Australia Bureau of Statistics, Bloomberg.

35Australia Government, Department of Agriculture, Water and Environment, Agriculture Forecasts and Outlook, December Quarter 2020.

36Data as of Dec 27 2020. S&P Global Platts, Bloomberg, Westpac.

37Goldman Sachs, Bloomberg.

38Reuters.

39World Gold Council, Metal Focus.

40*Funds with more than four members only. Source: Association of Superannuation Funds of Australia (ASFA), Superannuation Statistics, December 2020.

41Ibid 11

42Australian Taxation Office (ATO), ASFA

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