(for an average passive retail investor)
Traditional advise tells you not to own it
The most successful investors of our time, including none other than Warren Buffett, see little benefit in owning gold. Most often this is because it is not an income-generating asset and costs money to store and insure. This is probably the most important criticism of gold as an investment. Gold is a speculative investment by its nature. It is not income-generating. It does not have enough industrial or household uses to justify its current valuation. It is not a consumable good. This means that gold should be treated differently to most other assets that form part of a passive retail investor.
Historically, as can be seen from Chart 1, gold prices are dominated by multi-decade cycles. It may take decades to recoup an investment in gold should the timing be picked wrongly. In contrast, although it took 15 years for FTSE100 to recover back to its 1999 peak levels, if you had invested in an FTSE100 index at the 1999 peak, your investment would have seen a 70% increase by 2015 as a result of the reinvested dividend payments throughout this period.
The benefits of owning gold
Historically, gold prices have been driven by macroeconomic events, such as wars, that impact the certainty of the future. The current anti-globalisation trends, including Brexit and the election of Donald Trump as the US president, combined with elevated Debt-to-GDP ratios across the globe, increase the uncertainty.
Although gold in many ways is a less practical as a medium of exchange than fiat currency, it still provides the most viable medium of exchange alternative to state-issued currencies. The unprecedented synchronised quantitative easing measures taken by the world’s largest economies makes the future of state-issued currency less certain, and thus increasing the value of gold as the next-best alternative.
Lastly, gold’s value to a portfolio can stretch beyond its return potential. Such, gold can benefit as a dampener of portfolio value given its relatively low correlation to the stock market prices. It can thus play the role of an emergency asset that can be sold in times of distress at a more favourable value relative to other constituents in the portfolio.
How gold is currently priced
The first chart in this article tells that gold is currently priced at the top of its recent historic range. However, one may argue that the US CPI inflation does not reflect the recent quantitative easing measures, which resulted in the growth of asset prices (S&P grew by 250%+ between Jan-09 and Jan-20) but not consumer prices and to a lesser extend gold (growth of 78% between Jan-09 and Jan-20).
Looking at Chart 2 proves this point, indicating that the current gold price is historically cheap relative to the monetary base of the US economy (and many other large global economies due to the synchronised nature of quantitative easing).
Lastly, the gold price is lower than the historical average in relation to the S&P 500 index, supporting the under-priced gold thesis.
Conclusion
This analysis concludes that there are proven uses of having gold as a part of a diversified portfolio, especially if it’s a minority share. It can help dampen the fall during a recession due to its low correlation with other assets. It can also act as safe haven during uncertain macroeconomic times. However, it is not an income-generating asset and hence should not be chosen to represent a majority share of a typical passive retail investor.
How much to invest in gold would ultimately depend on how much certainty the investor sees in the future of the global economy. As the COVID-19 pandemic has shown, black swans exist and can have a global economic impact in a matter of months. And gold has shown to be good insurance against such risks.
P.S.
Recently, cryptocurrencies created the first viable competitor to gold as evidenced by over 60 central banks considering using this technology in order to issue state currency over the blockchain technology. Bitcoin, in particular, in many ways satisfies the criteria for a store of value commodity, which has previously been the gold’s monopoly.
Update 1.
The performance of gold commodity (blue lines) versus the gold producers (the orange line) is comparable if the starting point is chosen such that the gold price is comparable to the current levels. However, the equity has been more volatile. A high conviction in an expected rise in the price of the metal would warrant obtaining exposure via gold mining equity in order to act as a leverage.
Update 2.
Contango is not an issue in gold ETCs that are backed by physical gold, such as SGLN or SGLP (both similar sizes of c. $10bn).
Update 3.
Silver looks to be currently historically undervalued vs Gold. So it may make sense to invest a portion of gold portfolio into silver.
WisdomTree Physical Silver (GBP) | PHSP is a good vehicle in the UK.
- 0.49% ongoing charge
- Fund Size (Mil) USD 1318.52
- ISA elibible
Alternative is Invesco Physical Silver ETC (GBP) | SLVP.
Update 4. Who owns the world’s gold?
USD 9.3 trillion: That’s the estimated market value of all the gold ever mined, just over 190,000 tonnes, based on an end of August 2019 gold price of USD 1,528.40 per troy ounce.
The owners of this gold fall into four broad categories:
Jewellery Buyers — This is the largest category of demand, accounting for almost 50% of gold ownership. Jewellery demand is predominantly driven by rising real incomes in Asia and the Middle East, where gold is seen as a form of wearable wealth.
Central Banks — Central banks own gold as part of their foreign exchange reserves. Collectively, central banks around the world own more than 30,000 tonnes of gold.
Investors — Investors buy gold in physical bar and coin form, as well as through depository services, such as those offered by The Perth Mint, and via Exchange Traded Products. It is estimated that in excess of 40,000 tonnes of gold are held by private investors worldwide.
Industrial Users — Gold is used in a range of industries from medicine and electronics to space technology. Industrial users are estimated to own more than 25,000 tonnes of gold.
Who buys gold now?
The annual GFMS Gold Survey offers a great insight into gold demand trends. In 2018, purchases of gold were as follows:
- Jewellery demand was 2,129 tonnes
- Bar and coin demand was 1024 tonnes
- Central banks made net purchases of 536 tonnes
- Industrial fabricators purchased 391 tonnes
- Net flows into gold ETFs totalled 59 tonnes
Demand across the first eight months of 2019 has been driven by central banks, which continue to diversify away from the US dollar. This trend was perhaps best summarised by an August 27 Bloomberg article, Central Banks Just Love Gold and It’s Going to Stay That Way. The article focused on a report by Australian and New Zealand Banking Group (ANZ) which estimates net buying of gold by central banks will be more than 650 tonnes this year.
