Investing in gold

Gold has a history with investors. We examine why it's still an important player in the investor's toolkit.

Article updated: 11 October 2019 1:00pm Author: Tom Rosser

Gold’s appeal dates back for a number of centuries, whether it was a symbol of wealth, used as a currency or a store of value. Even though it no longer backs the US dollar, it still carries significant importance in today’s society and investors should be aware of the benefits it can bring to a portfolio.

What are the reasons to invest in gold?

Gold is ultimately a hedge against inflation. When inflation rises, the value of currency goes down because the fiat currency loses its purchasing power. Gold is seen as a store of value, and as such people are encouraged to buy it when their own local currency is losing its value. It is one of the few assets that are tangible, creating a perception of safety among investors.

In particular, the concept that gold preserves wealth is even more pertinent when investors are faced with a declining US dollar. Although the US dollar is the world’s most important reserve currency, when its value falls against other currencies it prompts a flock to the security of gold. Due to Gold being priced in US dollars, investors must sell their dollars to buy gold. This drives the Greenback lower, which in turn also makes gold cheaper for investors who hold other currencies. As a result, greater demand is seen from investors who hold currencies which have appreciated relative to the US dollar.

The increasing wealth of emerging market economies has also boosted demand for gold as the royal mint is often intertwined into the culture. Moreover, gold is often called the “crisis commodity” because people flee to its relative safety when world tensions rise – rising the most when confidence in governments is low. In a current environment which is gripped by trade wars, Brexit uncertainty and rising geopolitical tensions; this becomes all the more apparent.

Gold can help to improve portfolio diversification, as it generally has low to negative correlation with all other major asset classes. When equities are under stress an inverse correlation can develop, meaning that prices move in the opposite direction. Gold isn’t subject to the same macroeconomic and microeconomic factors that most assets classes are; therefore they don’t significantly influence the price of gold. Additionally, unlike investing in other real assets, such as Real Estate, investments in gold can be liquidated much faster. This can provide the same diversification benefits without the added liquidity risk. The combination of these can help to reduce the overall portfolio volatility.

What is the relationship between the gold price and the stock market?

It really depends on the period of time being analysed. Through certain periods gold has been shown to outperform stocks and bonds, whilst in other periods the reverse has happened. In theory, gold has a negative correlation with the stock markets. Correlations vary from 1 to -1, with 1 indicating that two securities move in exactly the same direction, -1 showing that they move in opposite directions, and 0 showing no correlation at all.

However, the correlation between gold and equity markets has varied over the years, ranging from 0.9 to -0.93 depending on the condition of the markets and the value of the US dollar. The median, a good measure of the average value, is around 0.04% - essentially meaning it does its own thing. Ultimately, the relationship between gold and the stock markets is a fluctuating one. The relationship can change quickly and as such gold can move with or against the market, as shown below.

How safe is investing in gold?

Investors must be aware the price of gold can be volatile in the short term; however it has always maintained its value over the long term. Its higher level of volatility is the norm, not the exception. Over a 40 year period the annualised standard deviation of the gold price is 18.84%, whereas the same figure for the S&P 500 is 17.09%. This indicates that the price of gold has varied to a greater degree than that of the US market. However, if gold is used part of a larger, diversified investment plan, it can be relatively safe to own whilst also providing the potential for positive returns when the rest of the portfolio is struggling.

Gold’s primary use is for jewellery, which makes up around 50% of gold demand. Further to this, roughly 40% of demand comes from the physical investment stemming from individuals, central banks, ETFs and other similar products. Therefore around 90% of gold demand is based on its intrinsic value, whereas fiat currencies are now backed by the promise of a government to make good on its obligations.

There’s only so much gold in the world; around 190,000 metric tonnes above ground and around 54,000 below ground. No one will be making any more of it, thus technological advances and price increases are the only way to increase the economically viable reserve of gold. Its physical nature provides its intrinsic value. By contrast, if the US government wants another dollar it just prints one.

How much does gold price grow annually? Is this the right time to invest?

Over the same 40-year period examined previously the compound annual growth rate (CAGR) of gold, a representational figure which makes it easier to compare investments, was around 3.5%. Conversely, the S&P 500 offered a CAGR of 8.5%. However, looking over a period dating 15 years back from the time of writing, which includes the effect of the Global Financial Crisis and its aftermath, gold has a CAGR of 8.82% and the S&P 500 has a figure of 6.52%. Gold has achieved this with lower annualised volatility too.

Recently the US Federal Reserve, along with other major central banks around the world, hasve been restarting the process of quantitative easing (QE). The lowering of rates in order to stave off a recession and keep growth alive will likely increase the US monetary base substantially over the next few years. From 2008 to 2015, the monetary base surged from roughly $800 billion to $4 trillion. As can be seen below, the price of gold tracked this increase, albeit tailing off in 2013 because market participants thought this would be a temporary measure, with the Fed eventually normalising and decreasing the monetary base. This may perhaps be a good indication of times to come should QE persist again.

What are the advantages and disadvantages of investing in gold?

Advantages:

  • Diversification benefits as gold is not correlated to stocks, bonds or real estate.
  • Currency hedge as the price of gold often rises when currencies, such as the US dollar, fall.
  • Inflation hedge because with rising inflation gold typically appreciates.
  • Economic collapse hedge as those who held gold during times of collapsing empires, political coups or the downfall of a currencies were mostly able to successfully protect their wealth.

Disadvantages:

  • No dividend revenue, investing great Warren Buffet is against precious metals as an investment.
  • Relative to equities, performance has been lower despite volatility being higher.
  • Subject to supply and demand forces so it’s only worth what the next person will pay for it.

Where to invest in gold market?

Physical gold coins or bullion: there is likely to be a huge mark-up on the price of the gold coins, bar or jewellery. Investors will also need to find a way of storing it and keeping it safe, which may be costly. Furthermore, you will also have to find a market to trade it through which can incur additional fees.

Exchange Traded Commodity (ETC): is often considered as the next best thing to owning physical gold, but unlike physical gold can be easily traded.

  • Invesco Physical Gold ETC is a low cost option, with a fixed fee of 0.24%, which aims to provide the performance of the spot gold price, after the impact of fees.

Funds: perhaps the best way to get a diversified solution. They are managed by experts and able to exploit both gold price changes and the effect this can have on companies involved in the supply chain.

  • Investec Global Gold invests around the world primarily in the shares of companies involved in gold mining. A concentrated portfolio that has performed strongly when gold prices have risen.

Shares of gold miners: the shares of these companies will usually track the metal. However, these come with additional risks since mining is expensive, time-consuming and often dangerous. Investors must be aware that investing in shares can be highly risky and gold miners in particular can be very volatile.

Conclusion

In light of current market conditions, investors should certainly consider adding a small amount of gold to their portfolios - probably around 5-10%. This can help increase diversification and ultimately the safety of the entire portfolio. The first graph illustrates the 36% fall of the S&P 500 during the Global Financial Crisis, a period where the price of gold rose 25%. This highlights the benefits investors can reap from owning gold, despite it being a more volatile investment instrument. Ultimately, if stock prices and a large number of investor’s portfolios are going south, then gold is likely appreciating in value as investors search out safe havens for their cash.


All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.

Tom Rosser

Investment Research Analyst

Tom holds a BSc Economics degree and an MSc Investment Management degree, and has passed both CFA Level l and CFA Level ll. He joined The Share Centre in September 2018 on the graduate scheme and is now an Investment Research Analyst on the fund research team. As well as being a fund commentator, Tom also comments across equities and other asset classes.

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