Investment Research

The Case for Gold Keeps Growing

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Jul 09, 2019

Published: 9th July 2019 Product in Focus: ETFS Physical Gold (ASX Code: Gold) Key Points Gold has been on a run in 2019 reaching a new all time high in AUD terms of over A$2000/ounce. Gold price is influenced by economic uncertainty and momentum Demand is high, driven by central bank and ETF purchasing Gold has been on a great run in 2019. US$ spot gold is up 9.1% since the start of the year and has recently been trading above US $1,400 for the first time since 2013 (as at 8th July 2019). In Australian dollar terms gold is hitting new all-time highs above A$2,000 an ounce. Fuelled by equity market volatility in late 2018 and recent heightened expectations of easing monetary policy, gold has performed precisely as would have been predicated by anyone anticipating the broader macro forces at work over the past year. Equity market volatility in early 2018 triggered a rally, which subsided as markets regrouped and set sail for new highs in the third quarter. Volatility returned the fourth quarter of 2018, driving gold higher again. All of this occurred with the backdrop of an abrupt shift in monetary policy from major central banks. To put gold’s price activity into context, it is worth looking at the historic drivers of the gold price. Research by the World Gold Council highlights the four broad categories of factors that influence the price of gold; This article looks at these four key factors in the context of the current market from a global perspective. Factor 1: Economic Expansion Despite much talk about the uncorrelated and counter-cyclical aspects of gold, like most assets, demand for gold is at least somewhat driven by the overall level activity and wealth in the global economy. Where savings and investment levels are high, demand for gold is high. Recent years have seen growing demand for gold from both India and China as levels of disposable wealth have grown. These two countries now account for more than 50% of global demand for gold. Conversely, a slowdown in the technology sector in late 2018 saw industrial demand fall by 3% in Q1 2019. While a broader economic slowdown seems to be in progress, the diversity of demand for gold and its traditional role as a strategic investment asset makes it unlikely that a reduction in economic activity will have a significant negative price impact on gold in the short-term. Factor 2: Risk and Uncertainty As an investment asset gold is commonly deployed as a portfolio diversifier, inflation hedge and quasi-insurance policy. Gold has shown persistently low levels of correlation with stocks and bonds over the long term, which means that the addition of gold to a portfolio is often able to improve risk-adjusted returns by adding diversification. Figure 3, below, shows the impact of adding gold to a typical balanced portfolio invested across Australian and international equities and fixed income (as represented by Vanguard’s LifeStrategy Balanced Fund). The conclusion here is that over the long-run a relatively small allocation to gold in a portfolio can have a consistent impact on the risk/return profile of the portfolio. In addition, gold can also have a substantial impact when other asset returns are stressed. This is evidenced in Figure 3(b) by the lower drawdowns, or losses experienced during the largest negative events. This leads us to gold’s commonly cited role as an “event risk” hedge. When major, unexpected events occur gold has, time and again, had a better outcome than equity markets. Figure 4, below, shows how gold fared versus the S&P 500 and ASX 200 through a selection of major financial events over the past four decades. When negative market events occur, gold’s correlation with mainstream asset classes tends to reduce and even become negative. This is in stark contrast to many other “alternative” assets, such as hedge fund strategies. During the global financial crisis, these were seen to be highly correlated to equity markets as investors simultaneously rushed to the exit of anything but the safest stores of value. Not only is gold highly liquid, its other important feature is that it has no credit risk. Unlike other asset classes, during times of financial stress when risk premiums are raised correlations between other assets rise as investors simultaneously look to sell, while gold often moves the other way on safe-haven buying. While such major events are unpredictable by nature, there is a growing case to be made that equity market valuations are currently stretched and that the volatility seen in early and late 2018 could well return in the near-term. Even if the monetary authorities are ahead of the curve and manage to engineer a soft landing, late-phase bull-markets are synonymous with bouts of volatility. As with any insurance policy, premiums are paid in the hope you never need to make a claim. Factor 3: Opportunity Cost The most common argument made against investing in gold is that gold has no intrinsic value because it produces no income and in fact produces negative income if you account for storage and security costs. This is certainly true in a literal sense. As has already been demonstrated, however, this should not detract from the role gold can play in a portfolio and the potential value it adds. The opportunity cost associated with holding gold is driven by the income and gains forgone by investing in gold over other asset classes. This is clearest in relation to bonds - when interest rates are high the relative cost of owning gold is high. Bonds may provide the necessary diversification, while also providing attractive levels of income. When yields are low, however, that cost of owning gold is reduced, making gold a more attractive play. In cases where yields are negative, as we currently see across Japan and the eurozone, gold effectively provides a positive yield. In the current market, not only are interest rates at the low end of the historic range, but monetary authorities, most importantly in the U.S., but also in Australia and Europe, have recently shifted from a normalisation/tightening bias, to a stimulatory/easing bias. Figure 5, below, demonstrates the very close relationship between gold and the U.S. 2-year Treasury yield over the past 18 months. Furthermore, over the past two easing cycles in the U.S. between 2001-03 and between 2007-08 gold appreciated by 31% and 17% respectively. Research by the World Gold Council also suggests that not only do lower interest rates raise demand for gold, but that interest rates have a greater impact on gold in periods where there is a shift in stance, which is exactly what we have seen over the past few months. Markets are now pricing a 100% probability of a Fed cut at the end of July. The likelihood of this was less than 20% as recently as late-May. Factor 4: Momentum Like most assets, gold is susceptible to trends and changes in momentum as it moves in and out of favour and the current trend is overwhelmingly positive. A key area of investment demand is from exchange traded funds (ETFs). Figure 6 shows that global ETF holdings have been steadily rising since early 2016. There are now over 74 million troy ounces of gold supporting physically-backed ETFs, which provide investors with access to gold on most global stock exchanges. ETF users range from larger institutional to small retail investors. Central bank demand is also growing and has been doing so since 2010. Net purchases are at historic highs and diversified across a wide range of nations. According to the World Gold Council 9 central banks added more than a tonne of gold to their reserves in Q1 2019. Conclusion In summary, gold has picked-up a strong tail-wind in recent months. Demand for gold continues to grow on multiple fronts. The case for using gold as a portfolio diversifier is also becoming clearer as interest rates decline and future growth prospects of global economies are questioned. For investors who are concerned with the risk of drastic, unexpected events it is hard to go past the track record of gold in helping to reduce losses in such scenarios. How to invest? Investors looking to add gold exposure to their portfolios can do so via ETFS Physical Gold (ASX: GOLD). GOLD is the oldest and largest gold ETF traded on the ASX. It is fully-backed by physical gold bullion vaulted on behalf of investors in the fund. GOLD charges a management fee of 0.40% per annum.

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Gold 2019 Outlook

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Jan 21, 2019

Gold 2019 Outlook Gold had a positive return of 9.4% in 2018 2019 is looking to experience further geopolitical instability, particularly: US/China trade tension Continued uncertainty around Brexit Gold net non-commercial long contracts have been on the rise since October 2018 Does it take a market correction to see the value in gold? 2018 wrapped up in a storm of volatility. Markets up for the first three quarters and down thereafter through to late December. Consequently, leaving investors wary of what may be on the horizon. Though we have entered a fresh year, many of these volatility drivers still exist as they remain unresolved. Looking at the geopolitical landscape, 2019 is likely to present events that will continue to affect market sentiment. Trade tensions between the US and China remain, Brexit is fast approaching the original deadline and elections are upcoming in India, the EU and Australia, with all expected to play a role in shaping the year ahead. With this continued uncertainty, defensive strategies and diversification shall continue to be on the mind of many. How did Gold weather the storm? The tail of 2018 saw gold perform as a good hedge against equities. Whilst the S&P/ASX 200 dropped 7.8% from October to December end, gold netted a 9.6% gain in this same period (Figure 1), which indicates inclusion of gold into a portfolio for the period could have reduced volatility and downside risk Examining several major indices across 2018, ETFS Physical GOLD had a positive return of 9.4% whilst all major equities were in the red (Figure 2). Gold outlook for 2019 The outlook for 2019 performance will likely be impacted by a continuation of the global themes that dictated the close of 2018. In the World Gold Council’s “Outlook 2019: Economic trends and their impact on gold”, it has outlined three important drivers of gold demand: financial market instability, the impact of rates and the dollar and structural economic reforms The political instability that has enveloped the leading economies of the US and the UK is set to continue with markets responding to ongoing turmoil. The protectionist attitude of the US has encouraged inflation, with gold used by many to hedge against this. These movements have heralded a renewed interest in gold which can be seen on multiple fronts. Net positive flows into ETFs have occurred for the previous three months, though Asian markets (including Australia) have lagged Europe and America on this front. Futures have also pointed to change in sentiment towards gold. Net non-commercial long contracts have been on the rise since October 2018, reversing the downward trend seen throughout 2017 and most of 2018 (Figure 3). The bearish view of gold suggests that performance could be constrained by a strong US dollar and rising interest rates. Addressing these points; the significant price movements of the dollar in recent weeks makes the price outlook of the dollar particularly tricky to predict. Examining the relationship between gold and interest rates, these have seen a degree of positive correlation in the past although not to a particularly significant degree. Finally, economic reform is expected to continue across China and India in 2019. As the greatest consumers of physical gold (through both investment and jewellery), economic growth in these regions will likely impact the precious metal. Further economic development and particularly the increase of wealth in India and it’s growing middle class is likely to continue to drive demand. On balance key indicators that have dictated the previous performance of gold suggest that we are likely to see a continuation in the upward trend of both investment flows and price of gold. Investors wanting to access gold may be interested in the benefits of exposure through investing in gold miners’ equities. Whilst this strategy gives the potential to receive dividends it does not offer the same exposure of a physical gold ETF such as GOLD as the price changes in gold miners can be quite different from the movement of gold price. The mining industry has recently garnered attention due to large M&A movements. Significantly Goldcorp will be acquired by Newmont Mining in a US$10bn deal. Subsequent to this announcement Newmont’s share price dropped 11% overnight. For investors who are utilising gold as an event risk hedge, other factors such as M&A activity can have unexpected effects on gold miner’s share prices. Therefore, a direct exposure to physical gold will eliminate exposure to stock specific risks.

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Why aren't you looking at Gold?

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Jan 08, 2019

GOLD 100% physically backed Highly recommended by Lonsec Recommended by Zenith Key features of Gold: Can materially reduce risk in portfolios The best-known hedge against the business cycle Outperformed cash since the 1800s Hedge against geopolitical events Global trends around Gold investment: Global Gold ETF investment flows have moved to positive for the first time since May 2018 Central banks have increased buying of gold to the highest level since the end of 2015 Gold is the world’s oldest financial asset and has been used for centuries in transactions and as a store of value. However, many Australian investors are hesitant to allocate assets to gold, with the lack of yield being a common concern. We believe investors should consider the role of gold in a portfolio, particularly with the recent volatility being experienced across the globe. Key features of gold 1. Gold can reduce the risk of a portfolio The most efficient portfolio is one that takes the least risk while making the highest return. Risk can be reduced by diversifying across and within asset classes based on low or negative correlations. Gold has low or negative correlations with traditional asset classes making it ideal as a risk reduction tool. 2. Gold has outperformed cash since the 1800s In a review of every major US asset class, Jeremy Siegel, a professor of finance at the University of Pennsylvania, found that gold provided investors with a real return of 0.5% from 1802 to 2016. He found that while gold was beaten by bonds and equities, gold outperformed cash, with cash delivering a negative real return of -1.4%. 3. Gold acts as a hedge against geopolitical events Gold has had an historical tendency to rise during times of crisis and turbulence. This means gold can provide something like an ‘event hedge’ – or the chance to reduce the impact of ‘black swan’ type events which, while relatively uncommon, can have a strongly negative impact on a portfolio. Taking the well-known example of the GFC (below) it can be seen that the difference between gold and the equity markets one year on from the credit crisis was 35% in favour of gold. Global trends of Gold investment Recent global movements have shown many investors are reallocating to gold. On this front Australia is lagging behind global trends with other regions showing a greater propensity for an allocation to gold. We have seen this increased appetite for gold emerging on multiple fronts: Gold ETF investment flows have moved to positive for three consecutive months (October-December) with 3% growth in ETF holdings in 2018 The total value of global gold backed ETF holdings in now over $100bn for the first time since 2012 Central banks have increased their buying of gold to the highest level since the end of 2015 What does gold look like in a portfolio? To demonstrate the effect of gold in a portfolio we have simulated the past performance of a series of Vanguard “LifeStrategy” funds with and without a 10% allocation to gold. Simulations were run over a 15-year period (since inception of ETFS GOLD). These funds provide an all-in-one portfolio made of globally diversified blends of equity and bonds (proportion equities & bonds indicated in charts below). In every case, the portfolio including a 10% allocation to GOLD outperforms and has lower beta and standard deviation indicating a lower risk. Based on this it’s clear gold does exactly what it’s meant to do from an investment perspective and we believe that many Australian investors are ignoring these risk reduction properties. Conclusion Gold is the oldest known store of value and has been continuously used for this function for centuries. We have demonstrated above the key features of gold that make it an appealing option for some investors. Gold’s low and negative correlations with other asset classes have seen it perform as an effective hedge in previous bear cycles and during global geopolitical events that have negatively affected other asset classes. Simulated data also demonstrates how this diversification can function in a hypothetical portfolio to reduce risk and increase returns.

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Putting the Spotlight on Defenders

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Nov 11, 2018

Key Takeaways Recent market volatility has encouraged investors to position portfolios more defensively ETF Securities has a selection of products more suited to a defensive strategy ZYUS gives a low volatility approach to the US market CORE gives exposure to the historically more stable infrastructure sector GOLD provides the best-known hedge against equity market downturn and political instability Introduction Investors have battened down the hatches over the past weeks as waves of volatility have dominated the market. Maybe the market calms down and equities resurge, but now, is clear, that late cycle volatility is here and will probably become more violent at each episode. The recent equity sell-off has heightened uncertainty, with consumer sentiment nicely described by the CNN ‘Fear and Greed Index’ that looks to characterise the primary emotion driving the market (see below). Right now, this index sits at 11, or ‘extreme fear’. Why? The consensus among investors appears to be that we’re in the ‘late stage’ of the investment cycle. Wall St’s thundering run has lasted a decade – the longest ever. And the market has become increasingly wary because of that. We have seen a very large sell-off in technology sector stocks with the Nasdaq, which is often taken as a proxy for US tech, recording its worst month since 2012. This suggests that some are losing faith in the continued performance of our recent equity stars (otherwise known as team FAANG). Adding fuel to the fire, the world has been curiously watching on as China and the US continue their game of trade policy tag. As the reverberations of any decisions by these heavyweights are felt by all, this tension is creating a difficult environment for investors. Playing Defence Though we are all familiar with the old adage ‘past performance is not an indicator of future performance’, it is sometimes helpful to look back at how previous storms have been weathered. The traditional market response to a late cycle downturn can generally be characterised by a move away from higher risk equities such as technology or emerging markets, greater focus on essential sectors such as healthcare, utilities and energy, and a general movement away from equities and into cash, short-term fixed income and commodities. As the bull market nears the close of its tenth year many are considering if now is the time to reposition portfolios towards ‘defensive’ assets. So, what are the options for investors looking to rearrange their holdings into a more defensive position? ** Gold is not considered in the risk illustration for two reasons. First, there is no counterparty risk with gold whatsoever (with cash there is still sovereign risk). Second, gold has historically had low correlations with equities, so its risk characteristics work differently. Defensive Equity Solutions America If you take a glance at global headlines, the US right now may seem a difficult market to play, with high levels of uncertainty around international policy and tariffs. However, as the world’s dominant economy, many would wish to maintain some sort of equity exposure but with a defensive tilt and an eye on capital preservation as much as growth. The ETFS S&P 500 High Yield Low Volatility ETF (ZYUS) is one option that is designed to achieve this. As suggested by the name, this ETF has a low volatility filter built into its index construction. The underlying assumption is that companies that don’t exhibit aggressive price movements are less likely to be sold down heavily in a general market sell off. Specifically, the index universe (the S&P 500) is ordered to select the 75 highest yielding stocks and then the 50 least volatile of those 75 are selected creating a high dividend paying, relatively low risk portfolio based on the trailing twelve months of price data. With reference to the chart above it is clear to see that, since the VIX jumped in October, IVV has lost approximately 10% whereas ZYUS has only lost 4%. Part of the reason for this is because ZYUS has a 16% greater exposure to utilities (historically low in volatility) whilst a 17% less to information technology (historically high in volatility) (as at 30th August 2018, source: S&P). Infrastructure Another strategy investors may consider in times of heightened volatility is increasing the allocation to sectors that have historically had greater stability. One such area known for this is infrastructure. The source of this stability can be explained by looking at the industries that fall into this sector: utilities, telecoms, industrials and transport. These industries typically have high capital costs, low elasticity of demand, long business timelines and often exist as regulated oligopolies or monopolies. Their capital-intensive nature means that they are very difficult and, in some cases, like energy distribution networks, nigh impossible to disrupt. This can mean that these sectors have lower risk (as measured by standard deviation of returns) than other sectors, such as technology or real estate. The table below illustrates the substantially lower volatility of infrastructure against these sectors.

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With Volatility Picking up, why Don't you Consider Owning Gold?

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Feb 09, 2018

With volatility picking up, why don’t you consider owning gold? Trade idea – ETFS Physical Gold (GOLD)/ ETFS Physical Singapore Gold ETF (ZGOL) Volatility has returned to the markets Downside risks have increased dramatically Gold has been consistently one of the best portfolio hedges against geopolitical risk and inflation Below we take a further look at why you should be holding gold There are three reasons why you should own gold. 1) Portfolio protection against volatility 2) Inflation hedging 3) Event risk hedging Points 1 and 2 have recently increased from “no concern” or “neutral” in investors’ minds to “serious concerns” so we believe that all advisers and planners should be considering including gold in their client portfolios, as it’s one of the most historically reliable hedges in such circumstances. Gold protects portfolios against negative equity volatility Just last week we had an example of gold performing as an event risk hedge when equity markets plummeted and the gold price surged upwards. On 5th February, we saw global equity markets fall with the S&P 500 down 4.1% and the ASX 200 down 1.6%, meanwhile the gold price was up 0.5% in USD terms as investors were turning risk averse. The year-to-date performance chart on the right highlights the price actions of the day. (Source: Bloomberg, data as of 13th February 2018) Historical performance is not an indication of future performance and any investments may go down in value. Gold against inflation Gold is also widely viewed as a tool against inflation. Historically, the gold price tends to appreciate when inflation and interest rates are on the rise. The chart below shows how the gold price moves largely in-line with the inflation (CPI) of the United States. Event Risk Hedge Lastly, although there have been no significant geopolitical events this year so far, it only takes one to roil the markets. As the table below shows, being in gold in nine out of ten of the events below was a positive when held within an investor portfolio. Summary There are three reasons why investors should own gold and two of them have dramatically spiked in terms of relevance. We believe all advisers should at least consider owning gold through this late economic cycle, where the probability of inflation and volatility is heightened.

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