Potential risks and challenges

31 March, 2023

Given the risk/reward trade off associated with any investment, it’s important to acknowledge and understand not only opportunities, but also key risks.

Non-standard valuation:  Gold does not directly conform to the most common valuation methodologies used for equities or bonds. Without a coupon or dividend, typical models based on discounted cash flows, expected earnings, or book-to-value ratios struggle to provide an appropriate assessment for gold’s underlying value. This presented an opportunity for the World Gold Council to develop a framework to better understand gold valuation.

Our gold valuation framework allows investors to understand the drivers of gold demand and supply and, based on market equilibrium, estimate their impact on price performance.

No cash flows: A well-documented perceived drawback of gold is that it does not provide any regular income whereas other asset classes, such as bonds, property or even equities, generate coupons, dividends and rents. This means that for investors to profit from gold, its price must increase. But in an era when other defensive assets like government bonds are providing low yield-to-maturities compared to history, gold’s zero yield has not been a major disadvantage.

Price volatility: Gold is a great diversifier to a portfolio because it behaves so differently to equities and bonds, not because it has a low volatility. And while gold is a less volatile asset than some equity indices, other commodities or alternatives, in some years the metal has posted close to 30% gains (2010) and in other years it has posted close to 30% losses (2013). On balance however gold has an asymmetric correlation profile with equities; in other words, it does much better when equities fall than it does badly when equities rise.