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Making gold an essential asset class for portfolios
GOLD stands out as a differentiated asset when it comes to navigating the complexities of global markets. Its one-of-a-kind risk-return characteristics have allowed it to maintain real value across diverse macroeconomic landscapes and through significant market disruptions – a rare feat.
Over the past two centuries, gold has withstood inflationary episodes and deflationary spirals, political revolutions and rapid technological evolution, localised conflicts and world wars, and pandemics.
Unlike other commodities and real assets that investors may consider for their inflation-hedging potential – such as copper, oil, silver and platinum – gold has limited industrial application and thus virtually no beta to business activity. While these assets share gold’s relative limited supply and history of retaining their real value during periods of inflation as the value of fiat declines, their sensitivity to economic activity impairs their reputation as potential hedges in periods of economic weakness and/or deflation.
Gold has historically maintained its real value over time, making it a rare asset capable of withstanding various economic conditions. This resilience makes gold a potential hedge against a variety of market, macroeconomic and geopolitical disruptions.
Gold’s qualities also set it apart from other financial assets considered for hedging purposes. The massive levels of sovereign debt in the developed world have increased the risk associated with government bonds, even as nominal and real yields have returned to levels last seen during the mid-2000s financial crisis. Options and other derivatives offer alternative hedging mechanisms, but come with limitations such as implementation costs, limited liquidity, and counterparty risk.
Cryptocurrencies have recently entered the hedging discussion, with advocates often referring to bitcoin as “digital gold”. However, cryptocurrencies are a very young asset class, and their behaviour across various economic regimes remains largely theoretical. In contrast, based on our experience, gold has served as a reliable store of value for millennia, maintaining its inflation-adjusted purchasing power through numerous existential threats.
Strategic gold allocations and exposure
There is no one-size-fits-all approach to gold allocation. Investors may adopt different levels of exposure and asset mixes based on their specific risk-return objectives and market expectations. For example, a well-diversified 100 per cent equity portfolio may require a higher gold allocation than a traditional 60/40 portfolio.
Investors can gain strategic exposure to gold through various methods, each with different risk-return profiles and liquidity characteristics. Bullion and gold-related equities are complementary methods for gaining gold exposure. Gold bullion is considered one of the most conservative forms of gold ownership, carrying minimal counterparty risk as it is already out of the ground. However, bullion offers no yield and entails storage costs, making it potentially less cost-effective.
We believe shares of gold-related equities, including miners and royalty and streaming companies, can sometimes be a cheaper way to gain exposure to gold than bullion. While this approach introduces operational risks and volatility, certain high-quality gold miners have historically added value for shareholders through operational execution, countercyclical capital allocation, or exploration success.
Royalty and streaming companies, which finance miners in exchange for ongoing economic interest in mineral production, typically diversify their risk exposure and demonstrate less price volatility than miners.
What is fuelling the recent gold price surge?
Recent years have seen a shift towards a less accommodative monetary policy regime, marked by tighter financial conditions and a host of acute risks. These include massive sovereign debt levels, ongoing fiat currency debasement, complex geopolitical dynamics, and systemic fragility – all these risks underscore the value of gold as a potential hedge. Despite a 300 basis point increase in real interest rates since the Federal Reserve began hiking its policy rate in March 2022, the gold price has risen by about 20 per cent.
While the gravitational pull of real interest rates is considered strong, gold’s resilience throughout the rate-hike cycle highlights that numerous factors are capable of impacting movements in its price, particularly over the short term.
It’s been our experience that the gold market sometimes serves as the metaphorical canary in the coalmine, sussing out potential dangers before they manifest in asset prices more broadly. We believe such dangers are plentiful in today’s environment.
Central banks have been a significant source of support for gold prices, with net purchases reaching record levels in recent years. Emerging market central banks, particularly in China, Turkey and India, have been the primary buyers.
Meanwhile, if appropriate, investors interested in potential safe havens in uncertain times may have ample reasons to consider gold amid a geopolitical backdrop – from Russia/Ukraine to the Middle East and China – that continues to deteriorate. And with federal elections scheduled in more than 70 countries over the course of 2024, including in the US, local politics also may spawn unforeseen policy shifts.
The massive accumulation of government debt worldwide may drive increased interest in gold as a potential hedge against currency debasement.
Gold’s differentiated attributes make it an essential asset class for some investors to consider. Of all available hedging options, gold’s risk-return characteristics enable it to potentially provide resilience in various adverse circumstances, including inflationary and deflationary environments and equity bear markets, while supporting real purchasing power across market cycles.
Gold’s historical resilience, low correlation to most major asset classes, and role as a potential hedge against a range of disruptions underscore its strategic value. Investors can tailor their gold exposure to help meet their specific risk-return objectives, leveraging both bullion and gold-related equities in an effort to achieve their goals.
We believe gold remains a vital component of diversified portfolios offering the potential for stability in an uncertain world.
Source: https://www.businesstimes.com.sg/