Assessing The Four Concepts of A Gold Investment Strategy

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Too often gold’s value is relegated to a simplistic analysis of supply and demand. This approach to understanding the strategic value of a gold investment ignores several other important aspects of the precious metal. For this reason, the World Gold Council recently released a comprehensive report PAMP Gold Barexploring the four factors that together represent the unique strategy of investing in gold. Here, we offer a summary of those four concepts and an explanation of why they matter.   

Returns that Outperform

Gold can improve the risk-adjusted return of a portfolio. Since 1971 the average annual return of gold has been almost 11%, placing it on equal footing with equities while also outperforming bonds. When examined over a period of 10, or even 20 years, gold has also outperformed other asset categories including emerging market bonds, EAFE equities, REITs, and hedge funds. This significant performance has enabled gold to outpace inflation by rising faster than increases to the consumer price indices (CPI). Moreover, gold has often safeguarded investors against inflation as evidenced by its average annual price increase of 15% during periods when inflation increased higher than 3%. This metric is especially relevant to investors today as concerns about inflation continue to rise. For example, publications like The Economist warn that factors like a 180% surge in shipping container costs are a harbinger of inflation.

Diversification that Works

In an increasingly globalized world, the diversification offered by index equity funds is diminishing. Additionally, diversification is becoming elusive as the returns of these funds is increasingly driven by fewer companies. Consider that a decade ago the five biggest US stocks represented 10% of the S&P 500. Today, the five largest stocks account for almost 25% of the same index. As a result, a handful of companies drive the movement of a basket of stocks meant to diversify a portfolio. For this reason the real diversification gold offers is critical in periods of falling equity performance. The metal increased in price by 21% between December of 2007 and February of 2009 when the global financial crisis wreaked havoc on investor holdings. As the World Gold Council shows, “gold has been more negatively correlated with equities in extreme market selloffs than commodities and US treasuries.”

Liquidity that Simplifies

Recent investor outcry has illustrated the importance of liquidity. In the early months of 2021 several prominent brokerage companies halted trading of several popular equities. The firms claimed this was necessary to prevent a collapse in their over-heated clearing houses. In contrast, gold offers more liquidity than the Dow Jones Industrial Average, US corporate bonds, and US 1-3 year treasuries, based on a measurement of one-year trading volumes in US dollars. This feature is important to investors who want the peace of mind that comes from knowing that there is a fluid market which will accommodate their trades at any time. Without liquidity an investor is not in control of their holdings because they do not always have the option to buy and sell. Part of gold’s liquidity comes from its lower volatility relative to US equities, EAFE equities, REITs, and more.

Long-Term Growth

The World Gold Council analyzed the average US pension fund portfolio over a five, ten, and twenty year period. Their conclusion: the average portfolio would have earned a higher risk-adjusted return with lower drawdowns if gold comprised 2.5%, 5%, or 10% of the total holdings. Additionally, their research showed 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.” This finding makes intuitive sense because so much of the value proposition of gold is differentiated from the value drivers influencing equities and fixed income investments. Simply put, gold is valuable for reasons that are wholly different from the value of a stock or bond.    

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