Published: 10 Sep 2018

Relevance of gold as a strategic asset

Reasons that make gold a strategic asset to invest in

A store of value, a bearer of hopes and emotions, and a currency; gold holds different meanings for different people. Apart from its versatility, the immense growth in India’s economic development over the past two decades has been the major reason for a substantial rise in gold’s consumer and investor base.

Gold plays four fundamental roles in any portfolio:

  • It provides a source of long-term returns
  • It mitigates risk, especially in times of political and economic uncertainty
  • It’s a liquid asset with no credit risk
  • It has outperformed fiat currencies such as paper money as a store of value. Fiat currencies are government authorised currencies that are not backed by a physical commodity. Fiat currencies derive their value from the relationship between supply and demand rather than the material from which the commodity is made

Recent research by the World Gold Council shows that in the last decade, adding up to 10% gold to the average pension fund portfolio would increase returns and reduce volatility, resulting in higher risk-adjusted returns.

Consumption and investment as drivers

The gold market has two attractive features for investors: (a) scarcity, and (b) a market large enough to attract institutional investors – including central banks. As long-term individual and national wealth expands, the demand for gold, both as an investment as well as jewellery, grows as well.

The many uses of gold – be it luxury goods, electronic component, investment, or portfolio diversifier – offer diversity in demand. Plus, the supply of gold is steady even during economic crises.

The risk diversification aspect is an attractive proposition to central bankers around the world. Since 2010, central banks of emerging market economies have been a net purchaser of gold demand.

Gold as a safe haven

The price of gold has, in the past 30 years, increased in times of systemic risk. Gold has been an effective hedge when market corrections have affected more than one sector, or lasted a while.

When the broader US economy fell into recession, gold prices responded more markedly. Similarly, investors outside Europe discounted the possibility of a spillover from the 2015 Greek default.

Gold is also less volatile than most stocks and commodities indices. Over 2007-2017, the realised volatility of stocks, stock indices, and gold is apparent in the chart below.

The fact that gold prices run counter to that of stock prices means that in times of rapid and sustained sell-offs, investors like the safety of gold when compared with other asset classes.

Gold as a source of returns

Gold’s value in times of uncertainty is well established, but what is less well known is that long-term returns from the metal have been comparable to stocks, and higher than that of commodities or bonds.

Gold trades in a large and liquid market, yet it is scarce. Mine production has increased at an average of 1.6% per year for the last 20 years. Consumers, investors, and central banks have contributed to higher demand, solidifying gold’s role as a strategic asset. Gold consumption in India, China, and the Middle East accounts for 60% of the worldwide demand.

The price of gold has increased by more than 14%, protecting investors when inflation has been higher than 3%.

Research by Oxford Economics shows that gold does well in periods of deflation.

The asset to beat all assets

Institutional investors want to maximise short-term gains. Individuals, however, prefer to minimise risk, and seek long-term returns. Being a liquid asset, holding gold – whether it’s in the form of ETFs, or as bars and coins – provides flexibility to individuals, institutional investors, and central banks, since it can be quickly realised in times of need.

Gold should no longer be seen as an ornament; it’s also an investment choice par excellence.

Article source- WGC report- The relevance of gold as a strategic asset