Undervaluing Gold: Why Asset Managers Don't See Its True Value (Yet)

From new research Asset Risk Consultants (ARC) shows that most asset managers have little to no exposure to gold. And if they do Buy gold, then that is more often a tactical move on price momentum than a fundamental position within the portfolio. Their research shows that 75 percent of asset managers have invested less than 2.5 percent in gold, and no fund holds more than 10 percent of assets in gold.

Many asset managers do nothing or almost nothing with gold (Source: ARC)

Investing in gold?

This is in line with previous findings that most asset managers do not have a structural position in the precious metal. Graham Harrison, chairman of ARC, argues that gold's investment fundamentals are weak from an investor's perspective. He mentions the well-known arguments, namely that gold is not productive and therefore it does not generate an income stream. And that's true, but at the same time it's not the full story. From the book From Gold to Bitcoin!

"From the perspective of an investor looking for yield, these arguments make sense. From that point of view, it makes sense to invest money in companies that produce added value for society. An investor who lends money or has shares in a company benefits from this in the form of interest or dividends. An investor also takes a certain risk, because the value of a share can also fall. If a company goes bankrupt, even to zero. Based on a company's results and balance sheet, investors can apply a variety of rational valuation methods. By comparing the value of a stock to, for example, profits, dividends, cash flow or book value of the company, an investor can reasonably estimate what the market value should be and whether a stock is undervalued or overvalued relative to that of other companies in a particular sector.

Such valuation methods cannot be applied to gold. Although it is possible to lend gold and generate cash flow in the form of interest, that is not where the precious metal derives its true value from. Only a fraction of all the gold is lent to the world. This is mainly done on the initiative of gold miners who want to fix the price for their future production. Therefore, this cannot be a criterion to determine the value of gold. For an investor, gold only has value if the price rises, because then price returns can be achieved. But because investors can't apply their valuation methods for stocks and bonds to gold, they don't see the value in it.

If you look at gold from this perspective, you will not understand its true value and will therefore rarely include gold in your investment portfolio. An investor will hold at most a few percent of gold, because the price of the precious metal has historically had little correlation with stocks and bonds. As a result, gold provides more diversification and can improve the risk/return ratio in a diversified investment portfolio. But that's the least important reason to own gold."

Why does gold have value?

Gold has value because it has no credit and currency risk, its quality remains constant and its supply increases at a low and predictable rate relative to the above-ground gold supply. The fact that gold 'does nothing' is in some cases not a weakness, but rather a strength. In the Western world, gold is often seen as an investment and compared to stocks, bonds and commodities. But gold cannot be categorized as such. The value of the precious metal is determined in a completely different way than that of shares and bonds. But what is gold? From the book From Gold to Bitcoin!

"Throughout history, gold has been selected by the market as the most suitable form of money and as an object to store wealth because of its unique properties. Gold no longer fulfils that first function since governments have taken over the monopoly Money Creation but gold is still a proven tool for storing wealth.

Wealthy people have long been looking for ways to protect their assets. For safety reasons, they cannot leave all their money in a bank account, because if a bank fails, their money is gone. If we look at history, we see that there are different ways to secure and store assets. In addition to financial assets, such as stocks and bonds, the rich also own numerous tangible, valuable and stable assets. Think of real estate, land, art, precious metals, gemstones, jewelry, classic cars and watches.

Seen in this way, gold is more comparable to other things that people buy to hold their wealth. All these assets fulfil the function of a store of value, because the supply of these types of goods is limited and increases at a relatively slow rate. Wealthy people buy these kinds of scarce valuables in the knowledge that many other rich people also do this to protect their wealth. Therefore, there will always be a lively market for these types of objects, the price of which continues to rise as economic productivity and the money supply increase."

Gold is wealth

Another important aspect is that the Stock to Flow Ratio of gold is exceptionally high compared to that of other (precious) metals and raw materials, because gold has few useful applications and is not consumed. Compared to other metals, gold is relatively rare, but compared to the practical applications of gold in today's economy, the precious metal is very abundant. Of the annual supply of mined gold, less than 10 percent is sufficient for industrial demand.

This means that every year a lot of newly mined gold remains, on top of all the gold that is already present above ground in the form of coins, bars, jewelry, decorations and ornaments. The abundant presence of gold and the relatively constant supply make this precious metal particularly suitable as a means of storing wealth. Gold is more of a means of parking assets than an investment in the traditional sense. And seen from that perspective, the precious metal has proven its worth several times throughout history.

The stock-to-flow ratio of gold

The valuation of gold therefore works differently from the valuation of, for example, shares or bonds. However, asset managers appear to be divided on gold's role as a store of value in turbulent times. In the long run, they see it mainly as a hedge against inflation, but apparently do not yet see the value of gold as the ultimate hedge against monetary or geopolitical crises such as a war or hyperinflation. In other words, they don't know how to value gold yet.

This shows that there is still a world to be won when it comes to the recognition and adoption of gold as an alternative safe haven to park assets in. And that also suggests that the Gold price still has significant upside potential, especially in view of the economic and economic Geopolitical developments in the world.

Would you like to read more analyses by Frank Knopers and Sander Boon? Through their Substack they publish regular updates. Frank Knopers and Sander Boon write a weekly market commentary with their views on the most important trends and events in the field of money, gold and geopolitics.