Intelligent Partnership still support physical gold
The latest edition of the World Gold Council’s ‘Gold Investor’ is out.
The price has fallen quite dramatically recently; however I am still a supporter of having Physical Gold within a portfolio – a modest allocation, certainly no more than 20% and more realistically less than 10%. Despite the recent fall in price, I feel it still has a role to play.
The role of gold within a portfolio
- Gold increases portfolio diversification: gold’s correlation to equities and bonds is, on average, 0.1
- Gold provides tail risk protection: by reducing portfolio losses during tail risk events
- Gold is a high quality asset: there is no credit risk investing in physical gold
- Gold is a liquid asset: Gold traded on average US$240bn per day in the first quarter of 2011, higher than the most liquid equities , German Bunds and UK Gilts
- Gold hedges against extreme inflation scenarios: like deflation and hyperinflation
- Gold protects against falls in developed market currencies: gold has a -0.5 correlation to the US dollar and a negative correlation to most developed market currencies
The cost of gold
Of course there is no such thing as a free lunch – all of these benefits come at a cost. That cost is in two parts:
Holding cost: there is a cost to holding gold, whether that is the TER and transaction charges on an ETF, or the premium, storage and insurance costs associated with physical gold. This cost is not hidden anywhere, there is no way to escape it – its money taken out of investors accounts
Opportunity cost: gold has no yield, so there is an opportunity cost – instead of holding gold, investors could have put their money into almost any other asset and achieved a yield – even cash.
Investors must take these two costs into consideration before they allocate any wealth to gold. The World Gold Council’s analysis suggests that small allocations are worth it for the benefits they bring to the overall portfolio performance.
Physical gold
Here at IP we are still fans of physical gold – the ultimate safe haven. Any other way of holding gold involves some counterparty risk. However, it is important to ensure that the holding is on a fully allocated basis. A broker running a partial allocation service (they don’t hold enough gold to cover all of their client’s positions on the assumption that they won’t all liquidate their gold at the same time) still has an element of counterparty/liquidity risk.
Demand for gold
The report makes some interesting points about where demand for gold comes from, and despite all the press the growth in gold investing via ETFs (and subsequent large withdrawals from these ETFs), they do not make up the majority of gold demand.
Investment demand accounts for 27% of total demand and is driven by larger dealings in the US and European markets, which can provide the capacity for these bigger transactions.
Jewellery demand accounts for 48% of total demand and is driven by domestic demand in Asia an emerging markets. This source of demand could well increase as levels of wealth rise in these countries.
Conclusions
Short term investing in gold still looks more like speculation than investment. However, there are strong reasons to hold a small allocation to Physical Gold as part of a multi asset portfolio as a risk management strategy.
To see the latest version of the latest edition of the World Gold Council’s ‘Gold Investor’ please visit http://www.gold.org/investment/research/regular_reports/gold_investor/