Japan 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 is an ESG investment).4

The increased relevance of gold

Institutional investors5  have embraced alternatives to traditional investments such as equities 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 1999 to 26% in 2020 – 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 eight-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
Sources: 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. 

A source of returns

Investors have long considered 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. he 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 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 yen*

Gold has outperformed most broad-based portfolio components over the past two decades*
Average annual return of key global assets in yen*
*Returns from 31 December 2000 to 31 December 2020. Computations in Japanese Yen Spot of total return indices for LBMA Gold Price PM, Bloomberg Barclays US Agg Total Return Value Unhedged USD, BPI Total Index, MSCI Japan Gross Total Return Local Index, MSCI Daily TR Gross EM USD, MSCI Kokusai Gross Total Return JPY Index, MSCI ACWI ex USA Gross Total Return USD Index, MSCI ACWI ex Japan Gross Total Return USD Index Bloomberg Commodity Index Total Return, ICE BofA Japan Corporate Index. Goldhub.com see: Gold returns. Source: 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. 
Computations in Japanese Yen Spot of total return indices for LBMA Gold Price PM, Bloomberg Barclays US Agg Total Return Value Unhedged USD, BPI Total Index, MSCI Japan Gross Total Return Local Index, MSCI Daily TR Gross EM USD, MSCI Kokusai Gross Total Return JPY Index, MSCI ACWI ex USA Gross Total Return USD Index, MSCI ACWI ex Japan Gross Total Return USD Index Bloomberg Commodity Index Total Return, ICE BofA Japan Corporate Index.

On Goldhub.com: 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 ten 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 yen from 31 December 2010 to 31 December 2020. See Chart 2 for respective indices. On Goldhub.com see: Gold returns. Source: Bloomberg, ICE Benchmark Administration, World Gold Council

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

*Returns in yen 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 9% in Japanese yen over the past 50 years, has outpaced the Japanese and world consumer price indices (CPI).13

Gold also protects investors against high and extreme inflation. In years when inflation was higher than 2%, 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 yen as a function of annual inflation*

Gold historically rallies in periods of high inflation, outperforming broad-based commodities
Gold and commodity returns in yen as a function of annual inflation*
*Based on y-o-y changes for the LBMA Gold Price PM, Bloomberg Commodity Index and Japanese CPI between January 1980 and 31 December 2020 in yen, based on available data. Source: 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 Japanese CPI between January 1980 and 31 December 2020 in yen, 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 8% in yen 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

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

Correlation between gold, commodities and Japanese equity returns in various environments of equity market performance since 1971*

Gold has been more negatively correlated with equities in extreme market selloffs than commodities
Correlation between gold, commodities and Japanese equity returns in various environments of equity market performance since 1971*
*As of 31 December 2020. Correlations computed using weekly returns in yen based on the Bloomberg Commodity Index and the LBMA Gold Price PM since January 1971 due to availability of data. The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on TOPIX weekly return falling by more than two standard deviations (or ‘σ’) respectively, while the bottom bar corresponds to the TOPIX weekly return decreasing by more than three standard deviations. The standard deviation is based on the same weekly returns over the full period. On Goldhub.com see: Gold correlation. Source: Bloomberg, ICE Benchmark Administration, World Gold Council

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

*As of 31 December 2020. Correlations computed using weekly returns in yen based on the Bloomberg Commodity Index and the LBMA Gold Price PM since January 1971 due to availability of data. 
The top bar corresponds to the unconditional correlation over the full period. The middle bar corresponds to the correlation conditional on TOPIX weekly return falling by more than two standard deviations (or ‘σ’) respectively, while the bottom bar corresponds to the TOPIX weekly return decreasing by more than three standard deviations. The standard deviation is based on the same weekly returns over the full period. 

On Goldhub.com see: Gold correlation.

 

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

The gold price tends to increase in periods of systemic risk

US equities, treasuries and gold versus the VIX index*

The gold price tends to increase in periods of systemic risk
US equities, treasuries and gold versus the VIX index*
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council *As of 31 December 2020. Return computations in US dollars for ‘US equities’: S&P 500 Index; ‘US treasuries’: Bloomberg Barclays US Treasury Index; ‘gold’: LBMA Gold Price PM; and ‘VIX’: Cboe VIX Index. The VIX is available only after January 1990. For events occurring prior to that date annualised 30-day S&P 500 volatility is used as a proxy. Dates used: Black Monday: 9/1987 - 11/1987; LTCM: 8/1998; Dot-com: 3/2000 - 3/2001; September 11: 9/2001; 2002 recession: 3/2002 - 7/2002; global financial crisis (GFC): 10/2007 - 2/2009; Sovereign debt crisis I: 1/2010 - 6/2010; Sovereign debt crisis II: 2/2011 - 10/2011; Brexit: 23/6/2016 – 27/6/ 2016; 2018 pullback: 10/2018 - 12/2018; 2020 pullback: 31/1/2020 – 31/3/2020.

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

*As of 31 December 2020. Return computations in US dollars for ‘US equities’: S&P 500 Index; ‘US treasuries’: Bloomberg Barclays US Treasury Index; ‘gold’: LBMA Gold Price PM; and ‘VIX’: Cboe VIX Index. The VIX is available only after January 1990. For events occurring prior to that date annualised 30-day S&P 500 volatility is used as a proxy. Dates used: Black Monday: 9/1987 - 11/1987; LTCM: 8/1998; Dot-com: 3/2000 - 3/2001; September 11: 9/2001; 2002 recession: 3/2002 - 7/2002; global financial crisis (GFC): 10/2007 - 2/2009; Sovereign debt crisis I: 1/2010 - 6/2010; Sovereign debt crisis II: 2/2011 - 10/2011; Brexit: 23/6/2016 – 27/6/ 2016; 2018 pullback: 10/2018 - 12/2018; 2020 pullback: 31/1/2020 – 31/3/2020.

Asset Performance during
market sell-off*
Performance during
market recovery*
  Average Median Average Median
Gold 10% 7% 25% 6%
US treasuries 11% 10% 13% 5%

*Average and median returns based on 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)
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council * As of 31 December 2020. Return computations in US dollars for ‘US treasuries’: Bloomberg Barclays US Treasury Index; ‘gold’: LBMA Gold Price PM. Dates used are based off the end dates of Chart 8. Post Black Monday: 11/1987 - 6/1989; Post LTCM: 8/1998 - 11/1998; Post dot-com: 3/2001 – 5/2007; Post 9/11: 9/2001 – 11/2001; Post 2002 recession: 7/2002 – 11/2004; Post GFC: 2/2009 - 1/2013; Post sovereign debt crisis I: 6/2010 - 10/2010; Post sovereign debt crisis II: 10/2011 – 2/2012; Post Brexit: 6/2016 - 7/2016; Post 2018 pullback: 12/2018 – 6/2019; Post 2020 pullback: 3/2020 – 7/2020. **The bar is truncated for the Dot-com bubble recovery due to its extreme differential between others and visibility.

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

* As of 31 December 2020. Return computations in US dollars for ‘US treasuries’: Bloomberg Barclays US Treasury Index; ‘gold’: LBMA Gold Price PM. Dates used are based off the end dates of Chart 8. Post Black Monday: 11/1987 - 6/1989; Post LTCM: 8/1998 - 11/1998; Post dot-com: 3/2001 – 5/2007; Post 9/11: 9/2001 – 11/2001; Post 2002 recession: 7/2002 – 11/2004; Post GFC: 2/2009 - 1/2013; Post sovereign debt crisis I: 6/2010 - 10/2010; Post sovereign debt crisis II: 10/2011 – 2/2012; Post Brexit: 6/2016 - 7/2016; Post 2018 pullback: 12/2018 – 6/2019; Post 2020 pullback: 3/2020 – 7/2020.
**The bar is truncated for the Dot-com bubble recovery due to its extreme differential between others and visibility.
 

 

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 ¥493tn, with an additional ¥119tn 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 the Nikkei 225, euro/yen and US 1-3 Notes, while trading volumes are similar to those of the S&P 500 (Chart 10). Gold’s trading volumes averaged approximately ¥19tn per day in 2020. During that period, OTC spot and derivatives contracts accounted for ¥11.4tn and gold futures traded ¥7.1tn per day across various global exchanges. Gold-backed ETFs (gold ETFs) offer an additional source of liquidity, trading an average of ¥341bn 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 yen*

Gold trades more than many other major financial assets
One-year average trading volumes of various major assets in yen*
*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. Source: 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 yen between 31 December 2000 and 31 December 2020. Computations in Japanese yen Spot of total return indices for S&P 500 INDEX, MSCI Daily TR Gross EM USD, MSCI Daily TR Gross EAFE 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 ,MSCI Japan Gross Total Return Local Index, Nikkei 225, MSCI Kokusai Gross Total Return JPY Index. On Goldhub.com see: Gold volatility. Source: Bloomberg, COMEX, World Gold Council

Sources: Bloomberg, COMEX , World Gold Council; Disclaimer

*Annualised volatility is computed based on daily returns in yen between 31 December 2000 and 31 December 2020. Computations in Japanese yen Spot of total return indices for S&P 500 INDEX, MSCI Daily TR Gross EM USD, MSCI Daily TR Gross EAFE 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 ,MSCI Japan Gross Total Return Local Index, Nikkei 225, MSCI Kokusai Gross Total Return JPY Index.

On Goldhub.com see: Gold volatility

4.   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 20 years underlines gold’s positive impact on an institutional portfolio. It shows that the Japanese pension fund average portfolio would have achieved higher risk-adjusted returns and lower drawdowns if 2.5%, 7.5% 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 4% and 13% across well-diversified yen-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 decade would have increased risk-adjusted returns of a hypothetical Japanese pension fund portfolio

Adding gold over the past decade would have increased risk-adjusted returns of a hypothetical Japanese pension fund portfolio

Performance of a hypothetical Japanese pension fund (PF) average portfolio with and without gold*

Adding gold over the past decade would have increased risk-adjusted returns of a hypothetical Japanese pension fund portfolio
Performance of a hypothetical Japanese pension fund (PF) average portfolio with and without gold*
* Risk adjusted return defined as portfolio return divided by annualised volatility and based on the total return indices in yen and benchmarks listed below based on performance between 31 December 2010 and 31 December 2020. The composition of the hypothetical average portfolio is based on a survey conducted by the Pension Fund Association on 18 January 2019 (for data as of FY2017). It includes total returns in yen for a 35% allocation to stocks (20% MSCI Kokusai, 15% MSCI Japan), 55% allocation to fixed income (30% JPMorgan GBI Japan Corporate Bonds, 20% Barclays Global Aggregate Corporate Bonds, 5% JPMorgan Japan Cash Index), and 10% alternative assets (6% Hedge Fund Research Absolute Return Index, 2% Tokyo Stock Exchange TOPIC Real Estate Index, 2% S&P Listed Private Equity Index). Gold’s performance is based on the LBMA Gold price in yen and the respective 2.5%, 7.5% and 10% portfolio allocations come from proportionally reducing all assets. Source: Bloomberg, ICE Benchmark Administration, World Gold Council

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

* Risk adjusted return defined as portfolio return divided by annualised volatility and based on the total return indices in yen and benchmarks listed below based on performance between 31 December 2010 and 31 December 2020. The composition of the hypothetical average portfolio is based on a survey conducted by the Pension Fund Association on 18 January 2019 (for data as of FY2017). It includes total returns in yen for a 35% allocation to stocks (20% MSCI Kokusai, 15% MSCI Japan), 55% allocation to fixed income (30% JPMorgan GBI Japan Corporate Bonds, 20% Barclays Global Aggregate Corporate Bonds, 5% JPMorgan Japan Cash Index), and 10% alternative assets (6% Hedge Fund Research Absolute Return Index, 2% Tokyo Stock Exchange TOPIC Real Estate Index, 2% S&P Listed Private Equity Index). Gold’s performance is based on the LBMA Gold price in yen and the respective 2.5%, 7.5% and 10% portfolio allocations come from proportionally reducing all assets.

 

Table 1: Gold has increased risk-adjusted returns while reducing portfolio volatility and maximum drawdowns

Comparison of a hypothetical Japanese pension fund (PF) average portfolio and an equivalent portfolio with 7.5% gold over the past one, five, 10 and 20 years based on yen returns*

  20-year 10-year 5-year 1-year
  No gold 7.5% gold No gold 7.5% gold No gold 7.5% gold No gold 7.5% gold
Annualised return 4.8% 5.2% 6.7% 6.7% 4.9% 5.2% 5.7% 6.6%
Annualised volatility 7.7% 7.4% 7.5% 7.2% 7.3% 6.8% 11.7% 10.8%
Risk-adjusted returns 0.63 0.71 0.89 0.92 0.66 0.76 0.49 0.61
Maximum drawdown -10.0% -9.2% -10.0% -9.2% -10.0% -9.2% -10.0% -9.2%

*As of 31 December 2020. The hypothetical PF average portfolio and weights are based on Willis Towers Watson Global Pension Assets Study 2019 and Global Alternatives Survey 2017 and as described in Chart 13. Risk-adjusted returns are calculated as the annualised return/annualised volatility. Maximum drawdown is calculated as the largest fall in a portfolio before the total value reaches a previous peak. 

Source: Bloomberg, ICE Benchmark Administration, 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 total returns in yen from December 1999 to December 2019 of MSCI Kokusai, MSCI Japan, JPMorgan GBI Japan Corporate Bonds, Barclays Global Aggregate Corporate Bonds, JPMorgan Japan Cash Index, Hedge Fund Research Absolute Return Index, Tokyo Stock Exchange, TOPIX Real Estate Index, S&P Listed Private Equity Index and LBMA PM gold price. Each hypothetical portfolio composition reflects a percentage in stock and alternative assets relative to cash and bonds; for example: 40/60 is a portfolio with 40% in stocks, commodities, hedge funds, REITs and gold, and 60% 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. See important disclaimers and disclosures at the end of this report. Source: World Gold Council

Sources: World Gold Council; Disclaimer

 

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 total returns in yen from December 1999 to December 2019 of MSCI Kokusai, MSCI Japan, JPMorgan GBI Japan Corporate Bonds, Barclays Global Aggregate Corporate Bonds, JPMorgan Japan Cash Index, Hedge Fund Research Absolute Return Index, Tokyo Stock Exchange, TOPIX Real Estate Index, S&P Listed Private Equity Index and LBMA PM gold price. Each hypothetical portfolio composition reflects a percentage in stock and alternative assets relative to cash and bonds; for example: 40/60 is a portfolio with 40% in stocks, commodities, hedge funds, REITs and gold, and 60% 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. See important disclaimers and disclosures at the end of this report. Source: World Gold Council

Sources: World Gold Council; Disclaimer

* Based on monthly total returns in yen from December 1999 to December 2019 of MSCI Kokusai, MSCI Japan, JPMorgan GBI Japan Corporate Bonds, Barclays Global Aggregate Corporate Bonds, JPMorgan Japan Cash Index, Hedge Fund Research Absolute Return Index, Tokyo Stock Exchange, TOPIX Real Estate Index, S&P Listed Private Equity Index and LBMA PM gold price. Each hypothetical portfolio composition reflects a percentage in stock and alternative assets relative to cash and bonds; for example: 40/60 is a portfolio with 40% in stocks, commodities, hedge funds, REITs and gold, and 60% 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. 
See important disclaimers and disclosures at the end of this report.

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 4% to 13% of gold to a Japanese-based portfolio 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 Japan

Increased allocations to alternatives

While gold has only recently started to make inroads as a trustworthy asset within the Japanese investment space, its potential to provide an effective portfolio diversifier in the face of various challenges is increasingly apparent to the country’s investors. The inclusion of gold in a growing number of defined benefit (DB) pension plans highlights this trend (Figure 1).30 The financial crisis of 2008 and the prolonged negative interest rate environment prompted long-term investors, particularly pension funds, to accelerate the inclusion of alternative portfolio assets as a means to diversify and generate additional returns. In an increasingly difficult environment – impacted by a number of structural issues unique to Japan – many investors recognise that they must manage asset allocation and review the effectiveness of alternative assets if they are to achieve their target investment goals. We believe gold can provide solutions that address such investor needs.  

Slowing growth and an aging population

The slow growth in the Japanese economy over the past few decades, along with a declining birth rate and aging population (Chart 2), have significantly widened the budget deficit and skyrocketed government debt. The IMF forecasts Japan’s budget deficit and public debt (Chart 2) to reach 14.2% and 266% of GDP respectively in 2020, the worst among OECD countries (Figure 3).  

The pandemic will likely further accelerate this trend. It is also estimated that the population of Japan will decrease – from 127.1m in 2015 to 101.9m in 2050 – while the percentage of those over 65, who are entitled to public pension benefits, will grow from 27% to 38% during the same period, making Japan the fastest aging society in the world (Figure 2). In the government’s efforts to cut spending and stabilise fiscal conditions it has initiated tax increases and cut pension benefits. 

As a result, growth of household disposal income has stalled and savings rates have sunk to an extreme low of 2.3%. The government is now openly encouraging people to save substantially more (Y20m has been suggested by one financial services agency report) to meet their retirement needs, primarily through moving away from low-interest bank savings to investment assets that generate higher returns. In so doing, the government is also emphasising the crucial role of asset diversification in protecting wealth accumulation. 

These structural issues create a number of other investment challenges. The aging population has led to an estimated 40% (minimum) of corporate pension funds experiencing net cash outflows (where benefit pay-outs are higher than premiums received), forcing investment managers to take a more conservative risk-return view and pay higher attention to liquidity management. 

 

Figure 1: Japanese pension funds continue to increase their allocations to alternatives like gold

Japanese pension funds continue to increase their allocations to alternatives like gold

Average Japanese pension fund allocation to different asset classes*
Japanese pension funds continue to increase their allocations to alternatives like gold
Average Japanese pension fund allocation to different asset classes*
"Corporate Pension Fact-Finding Survey Result for FY2018" published on January 16, 2020 Source: Pension Fund Association

Sources: Pension Fund Association; Disclaimer

"Corporate Pension Fact-Finding Survey Result for FY2018" published on January 16, 2020

 

Figure 3: Japanese government debt as a percentage of GDP ranks well above most major global countries

Japanese government debt as a percentage of GDP ranks well above most major global countries

Japanese debt as a percentage of GDP versus other major countries in 2019*

Japanese government debt as a percentage of GDP ranks well above most major global countries
Japanese debt as a percentage of GDP versus other major countries in 2019*
*As of October 2019, as reported in the IMF “Fiscal Monitor” Source: IMF

Sources: International Monetary Fund; Disclaimer

*As of October 2019, as reported in the IMF “Fiscal Monitor”

 

The mounting government debt problem has made investors more aware of the tail risks associated with Japanese Government Bonds, i.e. their vulnerability to extreme turbulence in equities, bonds, real estate and foreign exchanges, as well as other financial markets. 

Many experts also caution hard-landing risks, including possible hyperinflation following an unprecedented money-easing policy from the Bank of Japan (BOJ). The central bank’s exit from its massive JGB and domestic ETF purchase programs has the potential for a negative impact on the markets; a fact that is concerning to some investors. The BOJ currently owns 45% of JGBs and over 80% of domestic ETFs. 

Japanese investors face a combination of investment risks the like of which has never been experienced before: diversification risk, tail risk, credit risk, inflation risk and liquidity risk. Gold can offer effective risk management and mitigation at low cost while providing opportunities to improve portfolio returns. The average annual return of gold in the past 20 years has been higher than major traditional assets at 10.5% in yen. We believe the time is right for Japanese investors to put gold to work.

 

Figure 2: Japan’s population is expected to continue at steady rate over the coming decades

Japan’s population is expected to continue at steady rate over the coming decades

Japan’s total expected population and population by age over the coming decades*

Japan’s population is expected to continue at steady rate over the coming decades
Japan’s total expected population and population by age over the coming decades*
*"Population Projection for Japan: 2016-2065" published on July 31, 2017 Source: National Institute of Population and Social Security Research

Sources: National Institute of Population and Social Security Research; Disclaimer

*"Population Projection for Japan: 2016-2065" published on July 31, 2017

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 yen from 31 December 2000 to 31 December 2020.

8See Chart 13 on p9 for more details behind the composition of the hypothetical Japanese pension fund average portfolio. Based on 2000 – 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 Japan 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 2001 – 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

30"Corporate Pension Fact-Finding Survey Result for FY2018" published on January 16, 2020

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

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

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

Investors should discuss their individual circumstances with their appropriate investment professionals before making any decision regarding any Services or investments.

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

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

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