Gold can seem like a mysterious asset, but data suggests it has a clear value in a portfolio.
Setting the price
Gold prices are set by the London Bullion Market Association (LBMA) which also incorporates specific global standards for gold sales and receipt.
According to the World Gold Council, there are four broad sets of drivers to indicate gold’s performance1 which vary in their influence at different points in time.
Economic expansion: gold is used in jewellery, technology and long-term savings. These are areas that experience a boost in times of economic growth. These are also periods where inflation and interest rates may rise, and gold is traditionally viewed as a hedge against inflation.
Risk and uncertainty: gold has traditionally acted as a store of value in uncertain times and its demand can go up in market downturns, for example, demand increased in the early months of the global COVID-19 pandemic.
Opportunity costs: the costs and returns of other assets, such as bonds and currencies, can increase or decrease investor interest in gold.
Momentum: price trends, the use of riskier investments and general investment flows can direct demand for and therefore the price of gold.
The investment value of gold
Gold is included in portfolios for a myriad of reasons – diversification, growth, as a hedge against inflation, and for a volatility safe-haven. These reasons are backed by the data.
Gold has a low (and at times, negative) correlation to other assets as shown in the following chart. This means it performs differently to other asset classes thus assisting with diversification and in volatile periods in other asset classes.
The correlation between gold and major asset classes over 20 years
Australian Fixed Income
Global Fixed Income
Source: Source: Bloomberg data as at 30 September 2020. Correlations are calculated monthly over 20 years in Australian dollars. Australian equity is represented by the S&P/ASX 200 Total Return Index. Global equity is represented by the MSCI World Total Return Index. Australian fixed income is represented by the Bloomberg AusBond Composite 0+ Yr Index. Global fixed income is represented by the Bloomberg Global Aggregate Total Return Index.
Gold has also offered positive performance over the longer term against other asset classes as shown in the following chart:
Gold's 20-year performance against other asset classes
Source: Bloomberg, ETF Securities
Allocating to gold in a portfolio
Gold allocations traditionally spread from 2-10% of a portfolio depending on risk tolerance and market conditions. For many investors, taking a flexible approach may be the answer, dialling up or down allocations based on individual client portfolio needs and market activity.
For example, some financial advice firms, like Stockspot, have used a slightly higher allocation of 12% in recent times.
Using an ETF like ETFS Physical Gold (ASX Code: GOLD) may be a suitable option for many