As market volatility and global economic uncertainty continue to unsettle investors, financial advisers face the continuous challenge of managing client concerns while maintaining a sense of stability. This is why portfolio construction and understanding a client’s risk tolerance is crucial.
One asset that has historically proven itself to be a safe haven during tumultuous periods is gold. Although some investors may consider the precious metal to be old fashioned, gold has retained its significance as a store of value in a continuously changing investment landscape. As such, gold can provide portfolio diversification and act as a store of value in portfolios.
2023 has so far proven gold’s case as a portfolio insurance, particularly as economic and market conditions have seen the gold price reach record highs in US and Australian dollar terms. We explore what this tells us about how gold can be used in client portfolios.
Gold as a Safe Haven Asset
Throughout history, gold has earned a reputation as a reliable store of value. Unlike fiat currency, such as the Australian or US dollar, gold cannot be printed or artificially created because it is an inert physical commodity with limited supply. These properties grant gold the following advantages as an asset:
1. Hedge Against Inflation
Gold has long been considered a hedge against inflation, and for good reason. Since 1971, gold performance has consistently outpaced the US and world consumer price indices (CPI). This holds true during times of prolonged inflation, in which gold’s price has increased 8% per year on average.1 This performance is even more pronounced when inflation worsens to more than 5% per annum as gold prices surge, countering the inflationary effects.2 Gold has not only protected against capital erosion over the long term, but also brought significant appreciation against negative economic conditions.
2. True Diversifier
Diversification is key to portfolio risk management. As an investor, it may be difficult to find assets that are truly uncorrelated to market movements and global economic trends.
Gold separates itself as a distinct diversifier through its historically negative correlation to equities during market downturns. As a reputed safe haven asset, gold’s price often outperforms in times of volatility as investors pivot away from risk assets and toward portfolio insurance. This trait is particularly pronounced in times of systemic risk. For instance, during the recent regional bank collapses in the US or the first Covid-related crash in March 2020.
Gold’s quality as a diversifier does not end with portfolio insurance, as gold is also a reliable performer in times of positive market sentiment. Historically, gold has had a positive correlation during times of recovery following systemic selloffs. This is likely driven by gold consumer demand in luxury goods and manufacturing, as well as an increased investment demand as investors seek protection from future volatility and potential inflation risk.3 These qualities combined build a strong case for gold as a true diversifier as it demonstrates both an ability to be a quality long-term investment and insurance against market downturn.
3. High Liquidity
Liquidity is crucial for any investment asset, particularly one heralded as portfolio insurance, as it ensures investor flexibility without significant disruptions to pricing. High liquidity enables investors to swiftly respond to market changes, seize profitable opportunities, and manage risks effectively, making it a vital characteristic to consider when evaluating investment options.
It is significant then that the gold market is one of the largest, and most liquid markets in the world, with physical gold holdings by investors and central banks worth roughly US$4.8 trillion.4 The gold market is more liquid than the Dow Jones Industrial Average (DJIA) and has similar trading volumes to that of short-term US treasuries.5
This market depth and size means that retail and even institutional investors may never need to worry about liquidity risk even during times of economic uncertainty and market stress, ensuring flexibility and an ability for the investor to quickly adapt to market conditions.
How Much Gold Should You Hold?
Generally, advisers utilising gold as a core of their portfolio construction allocate ~5% to physical gold (via ETFs). This can be adjusted up or down depending on a range of factors like risk profile, market conditions and economic growth prospects. First and foremost, it’s important to assess your overall risk profile. If you’re looking for more portfolio insurance, you might want to increase your allocation to gold, and vice versa. Your views on market conditions also play an important role. For example, should you anticipate economic uncertainty or a market downturn, it could be wise to have more exposure to physical gold.
However, accessing physical gold can be easier said than done. While going out and personally purchasing gold bullion may provide the most “direct exposure” to gold, you will also have to navigate the risks of managing security, ensuring liquidity and other third-party costs. This is where an ETF can be helpful. Buying a physical gold ETF provides a low-cost way to invest in gold through a stock exchange. This way, you can both retain ownership of the bullion, and the issuer will take care of the storage and quality of your gold in high-security vaults, providing a good balance between direct exposure and peace of mind.
Investing in Gold
The contribution that gold could have in an investment portfolio cannot be underestimated. Its status as a safe haven asset and a true diversifier has stood the test of time. Demonstrated by its negative correlation to equities during market downturns, yet impressive long-term performance, gold has proven itself an attractive choice for risk management and portfolio stability. Considering the above, incorporating an appropriate amount of gold may just provide the diversified potential, and much-needed peace of mind that your client needs during these volatile times.
Risk Information
Investing involves risk, including the possible loss of principal. Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. The value or return of an investment will fluctuate and an investor may lose some or all of their investment. Before investing, you should consider seeking independent advice and read the relevant PDS and TMDs available at www.globalxetfs.com.au.
Want to learn more about Gold? Find out more about Global X’s range of commodity ETFs here.
1. World Gold Council. (March 31, 2023). Relevance of Gold as a Strategic Asset.
2. World Gold Council. (March 31, 2023). The case for a strategic allocation to gold: A deep and liquid market.
3. Ibid
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The value or return of an investment will fluctuate and an investor may lose some or all of their investment. Past performance is not a reliable indicator of future performance.
