There is another aspect that we have not yet addressed, and that is fundamental for those who are interested in the world of investment: its role as a strategic asset and element of diversification in an investment portfolio.
Among the many qualities that gold has is that of offsetting and balancing the assets that are part of an investment portfolio, maintaining an inverse correlation with them. In this way, it can play the strategic role of minimizing losses or offsetting returns when other assets fall.
Given the many unknowns that hang over the future of investors, we are going to analyze in this post how it can benefit them to increase their exposure to the precious metal.
Threats Of The New Decade
The Covid-19 pandemic has further complicated a situation that was already difficult from an economic point of view.
Among the factors that characterize the new decade that is beginning now, the World Gold Council cites the following:
- Low interest rates: Since the financial crisis of 2008, investors have had to deal with very low interest rates. Governments and central banks promote this policy of low interest rates to promote economic growth.
This drop in interest rates has a double effect on investors: on the one hand, it encourages them to look for assets with even greater risk, in order to achieve higher yields; on the other, it reduces the opportunity cost of owning gold and therefore encourages them to invest in the precious metal.
- Geopolitical uncertainty: In recent times there have been pockets of instability that worry investors. Among the most relevant are Brexit, the deterioration of relations between the United States and China, the increase in protectionist policies that affect global demand.
- All this harms the large European exporting economies, such as Germany, France, the Netherlands or Italy.
Generating Long-Term Returns
Historically, gold has generated long-term positive returns in both good times and bad.
The metal has appreciated by an annual average of 12% since 1971, when the gold standard ended. A return comparable to stocks and higher than treasury bonds. In addition, gold has outperformed other major assets over the past two decades, and is considered an excellent hedge against inflation (its 12% annual return since 1971 exceeds the European Consumer Price Index (CPI).
- And at times when inflation has risen above 3%, its average return has been 15%.
- Acting as a diversifying element and mitigating the losses of other assets in times of crisis.
- Gold is distinguished by its negative correlation with stocks and other risky assets, as was highlighted during the 2008-2009 financial crisis.
- At that time, stocks and other risk assets plummeted: hedge funds, real estate assets and most commodities, used as elements of investment portfolio diversification, also fell.
- Instead, gold not only maintained, but also increased its price, rising 27% between December 2008 and December 2009.
- Gold is especially effective in times of systemic risk, offering positive returns and reducing portfolio losses.
Providing liquidity without credit risk.
- Gold has the advantage of its enormous liquidity compared to other assets, which are difficult to sell and are undervalued when liquidating. This is because its market is huge and global in scope.
- According to estimates by the World Gold Council, the value of physical gold in the hands of investors and central bank
- The metal is more liquid than German bonds and European stocks, and its trading volume is similar to that of US Treasuries.
- In 2019, the daily volume of gold transactions was €136 billion. This guarantees liquidity that remains even in times of severe financial stress.
Improving the overall performance of the portfolio.
According to World Gold Council estimates, based on analysis of investment returns over the past 20 years, any portfolio would have achieved a higher return if it had been between 5 and 15% gold.
Furthermore, the impact would have been especially significant during the years of the global financial crisis. Although the decision to invest in gold rests with the investor or the portfolio manager, the truth is that the greater the risk of the same (in terms of volatility, illiquidity or concentration of assets), the greater amount of gold should be had to offset that risk.
Even if the average annual return of gold is reduced to 4-5% (much lower than today), its effect on returns is very significant. And this works both for investors with a risk profile and for those who prefer other more conservative assets such as real estate.