By Marcus Grubb
Gold has been the subject of intense discussion over the past month as price falls and ETF outflows have fuelled speculation over the future direction of the market. However, do these events really represent a substantial shift in the fortune of the precious metal?
Discussion over the investment case for gold has increased of late with April witnessing the sharpest two day fall in the gold price since 1983 and the gold reaching a two year price low of $1,321.35 per troy ounce. This uncharacteristically sharp decline in the spot price has sparked claims from bearish commentators that the tide may have turned for the gold market. In addition, much attention has been granted to gold ETF outflows with funds reporting all-time record withdrawals during April. However, this short-term focus fails to appreciate the value that gold can add as a long-term strategic asset, particularly at a time when financial assets continue to expand at an unprecedented rate.
Financial assets have grown at an unprecedented pace for more than two decades, driven by an increase in financial innovation and expansionary monetary policies. This boom in innovation, particularly the development of investment products lacking a physical backing, has allowed financial assets to grow ten-fold over the past 20 years. This is far in excess of the three-fold increase in nominal global gross domestic product (GDP) over the period. Despite the recent financial crisis, this trend is unlikely to subside.
The dramatic growth of ‘paper’ assets and elevated volumes of cross-border trading has escalated global imbalances in capital accumulation and borrowing, thus increasing both the potential for, and magnitude of extreme market events. As such, investors are increasingly seeking ways to balance their search for yield while strengthening their protection from heightened market risk.
Despite the fact that gold is well positioned to offer this risk mitigation, recent research shows that it remains a widely under-owned asset with holdings accounting for around one per cent of all financial assets held globally. Consequently many investors are taking disproportionate levels of risk in light of ongoing market uncertainty and would do well to consider the benefits an increased allocation to gold can bring.
Gold is a tangible asset that cannot be debased or devalued by expansionary monetary policies that have become increasingly commonplace in recent years. It is also highly liquid, with daily trading rates often at the same level or higher than for many equities, some major government bonds and certain currency pairs.
Gold has a key role to play in capital preservation strategies. It carries a very low correlation to other assets, including other commodities, which sets it apart as a strong portfolio diversifier. Furthermore, recent analysis has shown that portfolios containing gold outperform those without a holding of the precious metal during tail risk events in 18 out of 24 occasions. Gold also serves as a valuable hedge against developed market currency risk derived from its inverse correlation to the US dollar, as well as providing protection against extreme inflation scenarios.
Investors concerned over whether now is the right time to invest should consider the diverse set of demand drivers underpinning the gold price. ETF investment, for example, represents just six per cent of total annual demand for gold so recent outflows should not be viewed as indicative of overall investor sentiment. In contrast, we have seen record levels of physical buying around the world in late April and early May highlighting that the universal case for gold endures.
Institutional investors should view the current market environment as an ideal time to review their holdings of gold as a strategic asset within their portfolios.
Marcus Grubb is managing director, investment at the World Gold Council
Comments