Historically, Gold has always been a highly liquid asset. Yet it is still scarce compared to other commodities. Gold is often used as a luxury item, or in trace amounts of consumer electronics. At the same time, it is also a popular investment in many well-balanced portfolios.
Taken in this light gold can play a variety of roles. It is often a fundamental source of long-term returns, as well as a diversified which can mitigate losses when the markets are in distress. Gold is also a liquid asset without any credit risk and routinely outperforms fiat currencies. As a standard investment, it is also a means to enhance your overall portfolio performance.
Why Should You Consider Investing In Gold?
Gold has become an increasingly common investment, gaining in popularity since 2001. Since that time investment demand for gold has grown by around 15% per year, throughout global markets. In part, this trend has been driven in part by new access methods in the market. This includes things like physical gold-backed exchange-traded funds (ETFs), as well as the rapid expansion of the middle class in a variety of Asian countries. It has also seen a renewed focus in the United States and many European nations since the 2008-2009 financial crisis.
These factors have made gold increasingly relevant to institutional investors as central banks in developing markets start to normalize and implement new monetary policies, it could lead to higher interest rates, which could mimic the effects of quantitative easing for years to come.
Monetary policies like this have fundamentally changed the ways portfolio risk is managed. This could potentially extend the amount of time necessary to meet certain investment objectives.
Institutional investors have responded to this by embracing some new alternatives to traditional assets like stocks and bonds. We see this in how the share of non-traditional assets in global pension funds which have steadily increased from 15% in 2007 to a much high 25% in 2017. In the United States, this figure is actually closer to 30%.
Gold draws the attention of many investors thanks to its ability to act as a diversifier. This is largely due to its low correlation with many popular mainstream assets as well as its ability to hedge against systemic risk and strong pull-backs in the stock market. At the same time, there are many individuals who see it as a way to store their wealth in times of rising inflation.
How Strong Is Gold’s Return?
Taken in a certain light, gold is more than just useful during periods of increased economic uncertainty. Indeed, gold’s price per house has been increasing by an average of around 10% a year since 1971, when the United States started the process of abandoning the Gold Standard.
Gold’s price performance is strongly influenced by the fact that it can be used as a liquid asset. Yet it is still relatively scarce.
At the same time, gold minim production has increased by an average of around 1.5% each year for the past two decades. Over this same period consumers, investors and even most central banks have all contributed in their own way to increased demand for gold.
In recent years many savvy investors have wholeheartedly embraced gold-backed ETFs as well as similar investment vehicles in hopes of getting more gold exposure. It’s worth noting that since 2003 gold-backed ETFs have amassed more than 2,400 tons of gold which are estimated to be worth around $100 billion.
Does Gold Perform Well Above Inflation?
When the United States was still on the Gold Standard using the Bretton Woods system, the US dollar was still backed by the price of gold. At that time there was still a very close link between gold and United States inflation. When the Gold Standard was abandoned, the price of gold was effectively detached from United States inflation.
Since that time the returns on gold have steadily outpaced the United States consumer price index, due in large part to its many sources of demand. Taken in this context gold hasn’t just played a role in preserving capital, it has helped grow capital.
It’s also worth bearing in mind that gold has also helped to protect investors against times of extreme inflation. During times when inflation has been higher than three percent, gold’s average price has still managed to increase by an average of 15%. Yet on the other end of the spectrum, gold managed to also hold its long-term value during times of deflation.
How Has Gold Performed Against Major Currencies?
Since the turn of the last century, gold has managed to outperform all major currencies around the world. This trend even factors in times when major economies have defaulted, which sent their currency into a downward spiral. It also includes other sweeping change in global markets such as the end of the Gold Standard.
One primary reason for this strong performance is that the available supply of gold has changed very little over time. Even in the past two decades, when gold mining has seen a relative resurgence, the available gold supply has still only increased by roughly 1.5% each year.
How Does Gold Help With Diversification?
While many investors agree that portfolio diversification is important, it can still be hard to do it effectively. Things like market uncertainty and volatility can increase the sell-off of some investment decisions. At the same time, many so-called diversification experts have a tendency to fail to protect portfolios at the times when their represented investors need it most.
Take for example the early throes of the 2008–2009 financial crisis and the following recession. During that time hedge funds, broad commodities and real estate, which had been seen as effective portfolio diversifiers, were quickly sold-off right along with high-risk assets and stocks. Yet this was not the case with the price of gold.
Historically, gold benefits greatly from flight-to-quality inflows during heightened periods of risk. It does this by providing positive returns while also reducing portfolio losses. In this way, gold has been effective during times of major economic crisis when investors have the tendency to withdraw from stocks. At the same time, gold also helps investors to meet their liabilities at times when less liquid assets are being undervalued or potentially mispriced.
Since gold is also used as a luxury good investing in gold’s long-term price trends to also be supported by income growth. It also plays a role in many small consumer electronic goods, that more and more people rely on, or consider an essential part of life.
How Liquid Is The Gold Market?
Gold has been prized by pretty much every civilization throughout human history. This means that it also benefits from a large global market. It is estimated that around the world physical gold holdings by investors and central banks equals roughly $2.9 Trillion US Dollars. At the same time, it’s also believed that an additional $400 Billion is available in open interest through things like derivatives or exchanges.
Each day gold trades between $50 to $80 Billion, through spot and derivatives contracts. Gold futures trade also trade around $35 to 50 Billion in various global exchanges. Gold-backed ETFs also offer additional liquidity, at around $1 Billion each day.
Can Gold Help Enhance Portfolio Performance?
When we take all these various factors into account, it means that gold has several different ways to enhance your portfolio’s performance. Even in the past decade, institutional investors with an asset allocation equivalent to the average United States pension fund have benefitted from including gold in their portfolio. Simple adding a small percentage like two, five or even ten percent in gold during that time would have resulted in higher risk-adjusted returns.