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Gold As An Asset Class for Protecting and Building Wealth

Published by Karl Martin Karus in category Precious metals on 01.11.2022
Gold price (XAU-SEK)
19 829,99 SEK/oz
  
+ 35,74 SEK
Silver price (XAG-SEK)
243,65 SEK/oz
  
+ 2,01 SEK

Gold is a store of wealth and a hedge against inflation, currency depreciation, and systemic risk. Historically, it has provided better yields, improved overall portfolio performance, and provided liquidity in times of market stress. It is a perfect component for a well-diversified risk-averse and stable yield portfolio.

What affects the gold price?

In a structured approach, two main factors may be pinned down for pricing – opportunity cost and fear.

Opportunity cost is the value of the next-best alternative when a decision is made. Simple example: If you spend time and money to go to a movie, you cannot spend time at home reading a book, and you cant spend the money on something else.

Fear of missing out is often conflated with the economic principle of opportunity cost.

However, what factors actually determine gold pricing will always be subject to multiple factors and will always be debatable.

Since Gold holds no expiry, pays no dividend, and has a sentimental value – it’s rather challenging to determine the gold price based on traditional pricing models. Gold is priced at whatever people are willing to pay more than many other assets.

Investors usually move their assets in precious metals in times of uncertainty, and retail investors jump in when the market starts to move upwards. In the current economic climate, there are good potential options to start allocating some money to Gold. Gold tends to move upwards during high inflation times.

Gold Valuation

As is evident, Gold cannot be valued using generic valuation models for assets such as bonds, stocks, or other commodities. With no payout, maturity, projected earnings, or valuation ratios, generic pricing tools fail. Gold’s performance is based mainly on the intuitive foresight of the global economy as a whole. Among other factors, its outlook can be determined by four main vital drivers:

  • Uncertainty and risk
  • Economic growth
  • Momentum
  • Opportunity cost

The Gold Benefit

This precious yellow metal offers multiple benefits in an uncertain economic climate, with major digitalization also taking effect. Except for having Gold physically under one’s control and out of the financial system, Gold offers four fundamental advantages:

  • Returns over Long-term
  • Diversification and Loss Mitigation
  • Liquidity & Depth
  • Portfolio Enhancement

Long-term Returns – a strategic choice

Gold has acted as a stable and lucrative investment during uncertain times and has reaped long-term positive yields. Over almost half a century, Gold has grown by an average of 10% after delinking from the gold standard. This average growth rate is better than bonds and similar to equity. Over the last two decades, Gold has proved to offer intense competition to more “popular” investments.


https://www.gold.org/goldhub/research/relevance-of-gold-as-a-strategic-asset-2020-individual#chart2

The characteristic of Gold makes it stand out from the asset classes and develops its global acceptability. Gold provides excellent protection and wealth enhancement over the long term. And due to this, it is exchanged globally without any credit exposure. The metal has a sentimental value and has a healthy demand worldwide. These qualities make Gold resilient and adaptable over a growing and stagnated economy.

Gold and Inflation

Gold has had a reputation as an inflation hedge for a long time. Its average growth of 10% over the last 49 years has outperformed the US inflation. Gold has grown 10% over last 49 years. It grew 15% when inflation was 3% and 20% when inflation was 5%. This is proof that Gold grows in both economic environments – targeted inflation periods and high inflation times.

Read more about Gold and Inflation from our other blog post: Inflation and Commodities in 2022


https://www.funds-europe.com/news/gold-s-50-year-relationship-with-inflation

Gold and other Currencies

Before the collapse of the Bretton Wood in 1971, most currencies worldwide were pegged to Gold. After being delinked, Gold has outpaced all major currencies as a means of exchange. The primary reason behind this phenomenon is the restricted supply of Gold which has grown around 1.6% per annum.

From the beginning of the 21stcentury, major currencies lost around 90% of their value against Gold and 99% in the last 100 years.

Diversification & Loss Mitigation

The need for risk mitigants and portfolio diversifiers is accepted globally. However, these are not easy to pick. Most assets are linked with market risks and uncertainties, thus losing their ability to act as efficient diversifiers.

Gold stands tall; its reverse correlation with market assets makes it a perfect haven. The 2008-2009 market crisis made risk-based assets, stocks, hedge funds, real estate, and most commodities tumble. The S&P, during this period, shed 50% of its value, whereas Gold grew by 14%.

This is no shocker. Gold has progressively stood firm in high-risk and uncertain times. It has delivered positive returns and minimized portfolio losses during periods of systemic risk.

More importantly, Gold has provided liquidity to investors where other liquid assets crash and are hard to sell.

Interestingly, Gold’s quality does not only work in uncertain times, but it generates growth in growing economies and favorable markets.

Gold derives this duality by being an investment avenue as well as a luxury good at the same time. Gold’s unique nature makes it the perfect and most needed component of an investment portfolio.

Liquidity & Depth

No one can refute that Gold has a diverse, well-penetrated, and highly liquid market.

It is estimated that global gold holdings, including investors and central banks, amount to nearly US$3.7 trillion. While US$900 billion is spread across the OTC and derivatives markets.

Gold is accepted worldwide, and its liquidity is better than in several financial markets. Trading volumes for Gold in 2019 were US$145 billion compared to the US$ 78 billion of the OTC spot and derivatives market. Gold’s future alone marked a turnover of US$ 65 billion during the same period.

Portfolio Enhancement

A good portfolio offers high liquidity, stable returns, and adequate diversification. It can be achieved by portfolios that contain healthy levels of Gold.


https://www.gold.org/goldhub/research/relevance-of-gold-as-a-strategic-asset-2020-individual#chart7

Analysis of investment portfolios over 5, 10, and 20 years clearly shows Gold’s positivity on an investor portfolio. The above chart shows that a portfolio that does not contain Gold reaps a yield of a mere 0.62%, while an increase of 10% gold in the same portfolio can improve the return by 100 basis points.

Conclusion

To sum it up, it can be said that Gold’s reputation over the last 20 years has substantially improved. Its uniqueness of being a scarce, non-correlated, and highly liquid asset has proved it to be a genuine portfolio diversifier and stabilizer. Gold will continue to deliver excellent returns over the long run as it carries on its role of universal portfolio diversifier, luxury good, and investment avenue for times to come.

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