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Gold plays a key role as a long-term strategic investment and as a mainstay in a well-diversified portfolio. Gold's unique properties as a scarce, highly liquid, and uncorrelated asset allow it to act as a diversifier in the long run.
Gold's traditional role as a safe haven means that it comes into its own in times of high risk. But its dual appeal as an investment and as a consumer good means it can generate positive returns even in good times. This dynamic is likely to continue due to ongoing political and economic uncertainty and economic concerns surrounding equity and bond markets.
Gold does not directly conform to the most common valuation methodologies used for stocks or bonds. Without cash flows, typical models based on discounted cash flows struggle to provide an accurate assessment of the underlying value of gold.
Gold can strengthen a portfolio in two main ways:
Investors view gold as a favorable asset in periods of uncertainty. Still, it has historically shown good returns in both good and bad economic times.
Gold has long been considered a hedge against inflation, and the data bears this out: since 1971, it has outpaced U.S. and global consumer price indices (CPI). In years when inflation was between 2% and 5%, the Gold price by an average of 8% per year. So, in the long run, gold has not only preserved capital, but also helped it grow.
Historically, the major currencies have been pegged to gold. That changed with the unravelling of the U.S. gold standard in 1971 and the eventual collapse of the Bretton Woods system.
Fiat money can be printed in unlimited quantities to support monetary policy, as illustrated by the quantitative easing measures in the wake of the global financial crisis and the COVID-19 pandemic. In these crises, many investors turned to gold to hedge against currency devaluation and to maintain their purchasing power over time. In fact, a rapidly increasing money supply and low interest rates provide an optimal environment for gold to perform well.
Effective diversification in the investment portfolio is sometimes difficult to achieve. Many assets are becoming increasingly correlated as market uncertainty increases and volatility increases, partly due to risk-on/risk-off investment decisions, limiting the overall portfolio protection.
Gold is a great diversifier for a portfolio because it behaves so differently from stocks and bonds, not because it has low volatility on its own.
Gold's correlation doesn't just work for investors during periods of turmoil. It can also provide a positive correlation with stocks and other risky assets in positive markets, giving gold a well-rounded return. The addition of gold significantly improves the risk-adjusted return of a portfolio, either a portfolio with gold can provide a higher return at the same level of risk, or the same return at a lower level of risk.
Examples of correlations:
The term tail risk is a term used in statistics for the model 'the normal distribution'. The normal distribution is a probability distribution that describes how data is distributed. Normally distributed data has the following properties: observations around the mean are the most likely. The further away values are from the mean, the less likely it is to observe these values. Tail risks include those events (at the ends of the model) where there is a small probability.
Traditional portfolio strategies typically follow the idea that market returns follow a normal distribution. However, we often see that this model is out of line, with that 'small chance', and often on the negative side, occurring more often or the deviation from the average being (more often) larger. These abnormalities are called thick and long tails.
Why is this so important now? Good examples of such a tail risk event are, for example, Black Monday (1987) and the Credit Crisis (2008), in which stock markets fell sharply. The effect of such a tail risk on the return of a securities portfolio is very large. Gold does very well in these kinds of tail risk events, especially when the turmoil focuses on confidence in the financial system.
In the present time, economic, political and social developments may be on the eve of a fundamental change of course. Multiple escalations occur simultaneously and have the potential to blow each other up further. These escalations can have an impact on the financial markets, which translates into tail risk events. These types of events can present themselves more often and to a greater extent. It is therefore even wiser to insure yourself against this by buying precious metals.
How much gold someone buys is a personal decision Below are some points to consider.
Do you have any questions? Then come by for a consultation at one of our offices in Alkmaar, Rotterdam or Ellecom or contact us by phone on +31 (0)88 4688400
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