Bullish on bullion? Discover gold’s role as a diversifier.
This article provides insights into the unique characteristics of gold and the role this asset can play in building a stable portfolio.
Introduction
Gold is one of the most ancient places to store wealth. From an investment perspective, gold has historically acted as a safe haven asset during times of market volatility.1 The Smart Gold ETF (GLD) is an exchange-traded fund that offers investors the ability to access the gold market without needing to own gold bullion.
About gold
The world’s gold
The first gold coins were struck in 560 B.C in the Kingdom of Lydia (now part of western Turkey) and it has been used as a medium of exchange and store of value throughout history.2 Gold is virtually indestructible and much of the gold that has ever been mined is still in existence in some form.
The World Gold Council estimates there is 212,582 tonnes of gold ‘above-ground’, of which two-thirds has been mined since 1950. To visualise this amount of gold, it would fit into a 22-metre square cube, roughly two tennis courts. There is also an estimated 59,000 tonnes of gold in proven reserves which is yet to mined.
Of the ‘above-ground’ gold, 45% is in jewellery, 22% is in bars and coins and held as an investment, including by gold-backed Exchange Traded Funds (ETFs). Another 17% is held by central banks as part of their reserves.
Source: World Gold Council
Demand for gold
Based on figures from the World Gold Council, 52% of the annual demand for gold is for jewellery, with another 8% from industrial users. The remaining 40% of demand is for financial purposes, from investors buying gold bars or coins and buying from central banks around the world, or funds like Exchange Traded Funds.
Source: World Gold Council
Gold as an investment
A safe haven asset during times of volatility
Gold is not a conventional investment like the main assets: cash, bonds, property and shares. All of these assets provide an income stream from interest, rents or dividends, while gold provides no income. Despite this, gold’s physical properties as a valuable precious metal, scarcity, and role in the international monetary system has cemented its ability to help preserve wealth and purchasing power through the ages.
Unlike cash which can lose value in the face of inflation, gold has a sense of enduring value. A small allocation to gold within a balanced portfolio can help investors build resilience in their portfolio by potentially offering a degree of downside protection during economic and financial uncertainties.3
Gold as a diversifier
Diversification isn’t simply about having a range of different securities and assets in your portfolio. It’s about having securities that respond differently to the same factors or market situations such that if one security or asset class performs negatively, the other securities or asset classes could potentially cushion some of those losses. It is important to note, while effective diversification can help mitigate volatility, it may not fully protect you from market risk.
Correlation of returns is a concept which can help investors create a diversified portfolio. It is a statistical measure which describes how closely two investments move in relation to each other. It ranges from +1 to -1. A higher correlation means the assets behave quite similarly in most scenarios. A correlation of 0 means the assets are not correlated, while a low correlation means the investments or asset classes have relatively different reactions to the same factors.
As illustrated below, the performance of the price of gold has a low correlation with New Zealand and global shares and bonds. This means gold can play a role in a portfolio as a diversifier and a potential hedge against inflation and periods of heightened uncertainty. Gold is a higher risk investment and should represent only a small proportion of a balanced portfolio.
Source: Bloomberg data (2004-2020). Indices used: S&P GSCI Gold Index (Gold), S&P/NZX 50 Index (NZ shares), MSCI World Index (Global shares), S&P/NZX Investment Grade Corporate Bond Index (NZ bonds), Global Aggregate Index, hedged to NZD (Global bonds).
Recent past performance of the gold price
The gold price has performed strongly over recent years, rising 58% in US Dollar terms over the two years from September 2022 to September 2024.4 This rise occurred during a period marked by higher inflation, an escalation in global geopolitical risks and, more recently, a fall in interest rates.5 The chart shows the performance of gold, along with United States shares and inflation over the 30 years from 1994 to 2024.
Past performance is not a reliable indicator of future performance.
Source: Gold (Gold Spot Price and US Dollars) and US shares (S&P 500 Total Return index) sourced from Bloomberg. US Inflation (CPI Index) sourced from St Louis Federal Reserve. All in US Dollars.
Risks
Gold is a high-risk investment and should represent only a small proportion of a balanced portfolio. The risks of gold as an investment include:
No income stream
Gold provides no income stream, meaning there is no ongoing cashflow and any return will only come from an increase in the gold price.
Volatility
The gold price can be highly volatile. Over the four years from 31 December 2012 to 31 December 2015 the gold price fell 36% in US Dollar terms.6 Differing market and economic conditions may impact negatively on the performance of the gold price.
Growth potential
While regarded as a store of value, growth assets, such as shares, have provided higher returns than gold over the longer term. Over the past 30 years from 1994 to 2024, the gold price in US Dollar terms has risen on average by 6.4% per annum while United States shares have returned 10.8% per annum.7 Past returns are no indicator of future returns.
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iShares® and BlackRock® are registered trademarks of BlackRock, Inc. and its affiliates (“BlackRock”) and are used under license. BlackRock makes no representations or warranties regarding the advisability of investing in any product or the use of any service offered by Smartshares Limited.
Past performance is not a reliable guide to future performance. The calculations and returns used in this article are illustrative and intended as a guide only, and are not an indicator of future returns. The value of investments can go down as well as up and investors may not get back the full amount invested nor any particular rate of return referred to in this article. Returns are not guaranteed. This information is intended to provide a general guide and is based upon, and derived from sources Smart considers reliable. Neither Smart nor NZX Limited, or their respective directors and employees accept any liability for any errors, omissions, negligent misstatements, or for the results of any actions taken, or not taken in reliance on this information. This information is not a substitute for professional advice. In preparing this information Smart did not take into account the investment objectives, financial situation or particular needs of any particular person. Accordingly, before making any investment decision, Smart recommends professional assistance from a licensed Financial Advice Provider is sought.
Published in November 2024
1 iShares, Diversify your portfolio with gold.
2 National Mining Association, The History of Gold
3 iShares, Diversify your portfolio with gold.
4 Bloomberg
5 US annual inflation averaged 8.0% in 2022 after being 1.2% in 2020, St Louis Federal Reserve. The annual rate of inflation averaged 7.2% in New Zealand over 2022, Reserve Bank of New Zealand. Geopolitical risks include the conflicts in Europe and the Middle East. On 18 September 2024, The Federal Reserve (the United States Central bank) lowered the target range for the federal funds rate by 0.5% to 4.75% to 5.0%, Federal Reserve FOMC. On 9 October 2024, the Reserve Bank of New Zealand cut the Official Cash Rate by 0.5% to 4.75%, RBNZ OCR.
6 Bloomberg