Mutual funds need to buy more gold

Negative interest rates on government bonds and stock market records make gold an attractive alternative. The precious metal also offers more diversification within a diversified investment portfolio in the event of negative interest rates. This is what the World Gold Council in a new report released this week. According to the organization, the expectation that interest rates on government bonds will remain low for a long time justifies a higher weighting of gold in the investment portfolio.

Due to low interest rates, investors are seeking refuge in alternatives such as hedge funds, private equity and real estate. These investments have a higher risk profile, which justifies a higher weighting in gold. The precious metal has little correlation with other investments and is ideally suited for risk diversification in the portfolio. Especially on days when stock markets are down, gold tends to perform well.

'Equities and government bonds overvalued'

According to the World Gold Council, equities are relatively expensive at the moment, when you compare the average earnings over the past ten years with the development of the US 10-year yield. Also, government bonds are relatively expensive. For example, 26% of all government bonds in developed economies now have negative interest rates. If we look at the real interest rate, which also includes inflation, we see that even 82% of all government bonds yield a negative return.

One of the main arguments against Buy gold, namely that it does not yield interest, is therefore no longer applicable. The precious metal does not generate any income, but that is still better than putting money into a government loan. Historically, gold performs best at negative real interest rates. If interest rates remain at this low level, the future looks favorable for the precious metal.

Strong correlation between Gold price and negative interest rates (Source: World Gold Council)

Negative interest rates good for gold

Research by the World Gold Council shows that gold performs significantly better in times of negative real interest rates. Since 1971, the precious metal has yielded an annualized return of 15.3% during these periods, almost twice as much as the average annual return from 1971 to the present. That is why investment funds and pension funds should add more gold to their portfolios now that interest rates are so low.

The era of negative interest rates on government bonds calls for a different distribution within the investment portfolio. Based on historical returns, the World Gold Council recommends a weighting of 2 to 10 percent in gold, but based on current interest rates, a higher percentage is justified. The chart below shows what that means for traditional investment portfolios with a mix of stocks and bonds and for pension funds.

According to the World Gold Council, pension funds in particular are currently at risk. Their liabilities are based on an annual return of 7% to 9%, while government bonds provide almost no return. This means that pension funds will have to include more risky investments in their portfolios. And that justifies a heavier weighting of gold as a form of diversification.

Negative interest rates justify more gold in the investment portfolio (Source: World Gold Council)

Pension funds should also own more gold in the event of negative interest rates (Source: World Gold Council)