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The dazzling splendor of gold investment

March 3, 2020

reading time: 7min

by Ikram Boulfernane, Financial Economist LGT Capital Partners

golden sportscar

Gold - is it just an ordinary commodity that beautifully shines, or is it an ultimate hedge and crisis currency in economically precarious times?

The environment for investing couldn't be much more challenging: The global economic slowdown, the international trade dispute, geopolitical turmoil, global tensions and uprisings – these are just some of the aspects that make international investors look for safety.

Added to this are the steadily rising sea of debt and the global deluge of money – including low and negative interest rates and manipulated currencies that are eating their way through capital assets and retirement provisions. The globally important central banks are degenerating into money printing machines for highly indebted nations, and savers and investors are losing out. Such developments have furrowed the brows of investors, and Botox in the form of safe havens is in demand to help smooth out these wrinkles a bit. Are gold investments really addressing the needs of investors within such an environment?

Gold buillons - symbol of stability for investors?

Debt levels, money supply, low interest rates, currencies – all these variables can be freely manipulated by political actors. But not gold! The commodity has no counterparty and many investors consider it a safe haven for their wealth. For millennia, gold has withstood every crisis and survived failed paper money adventures. In this consequence, it is used to hedge wealth against political and economic risks. The more severe the structural crises are and the bleaker the economy looks, the more analysts underline the shining strength of investing in gold.

The finiteness of gold reserves and the eternal durability of the precious metal contribute to its intrinsic value.

As a store of value, it helps to maintain purchasing power despite constantly rising price levels. This can be illustrated by the cost of clothes. In the old Roman Empire, the price of a toga was an ounce of gold. To buy a quality suit today you will probably have to dig just as deep into your pocket. Paper money from the last millennium, on the other hand, is probably no longer even worth the paper on which it was printed and can be safely disposed of in the circular filing cabinet. In contrast to paper money, gold cannot be produced at will. The finiteness of gold reserves and the eternal durability of the precious metal contribute to its intrinsic value.

The demand for gold is mainly for the manufacture of jewelry and as an investment instrument, including central bank purchases. The material is also used in the technology industry. China and India are among the largest consumers of gold. In those two countries the traditional demand for gold jewelry is rising as prosperity increases. Demand from central banks has also risen massively. In 2018, the largest purchases of physical gold in the last 50 years were recorded. The purpose of holding gold in currency reserves is to help stabilize currencies. Storing large numbers of gold bullions, the central banks are pursuing three objectives: to protect assets from loss in value, to maintain liquidity and to generate returns.

Gold coins vs. gold ETF - does it belong in your portfolio?

International gold trading is mainly conducted in US dollars and troy ounces. The greenback and the yellow precious metal tend to show a negative correlation to each other. If the US currency depreciates, it will have a supportive effect on the global gold price, as buyers outside the U.S. dollar area can purchase the commodity more cheaply.

Interest rates are also an important price driver. The more interest rates decline, the lower the opportunity costs of holding physical gold, as its competitiveness increases against interest-bearing assets. In contrast to equities and bonds, gold does not generate dividends or interest income. Profits can only be achieved through price changes. The current market environment is characterized by falling and even negative real interest rates. At the same time, an aging bull market seems to be addicted to support measures. This creates an environment, where many investors re-evaluate the qualities of gold.

As an investment instrument, gold is highly suitable for diversifying a portfolio. The correlation of the yellow precious metal to other asset classes is dynamic owing to its dual function of both consumer good and investment vehicle, and changes in the course of the economic cycle. In good times, gold can move in the same direction as risk assets such as equities because more jewelry is in demand. In bad times, the idea of hedging increasingly comes to the fore because investors are looking for high-quality and liquid investments to protect their capital and minimize losses.

Thus, the precious metal might support the stability of a portfolio and its risk-adjusted return. There may be some discussion about what the right percentage of gold in a portfolio is, but various empirical studies see 1% to 9% as appropriate. This applies to risk-averse investors as well as to those who are willing to take more risks. For institutional investors, gold is likely to play a more tactical than strategic role in asset allocation.

Buying gold – but how?

The international gold market is extremely liquid. The daily trading volume is estimated to be between U.S. dollar 100 and 200 billion. For investors who want to participate in the gold market there are various possibilities. They can physically purchase gold in the form of gold bars, coins, or ounces – the oldest and most expensive way. After all, if one is heading for a safe haven, he or she has to reckon with port administration fees for the coins or bars. Storage and insurance costs are incurred. Obviously, the traditional bunker for your bullions under the mattress should not be used due to the various dangers involved in this type of storage.

An alternative would be to use exchange-traded funds (ETF). Gold ETFs are designed to track the price of gold in global markets. They are liquid financial products with low transaction costs and are therefore particularly suitable for private investors. Another possibility is to buy gold futures on the futures market. This is suitable for experienced investors who want to participate in price movements but are not interested in physical delivery. In the case of a long-term commitment, futures contracts must be sold regularly before maturity and replaced with ones of longer maturities – this is referred to as “rolling”. An additional option to participate in the gold market would be to buy the shares of gold producers.

Gold has a large base of followers, ranging from Fort Knox to Duckburg. For thousands of years, its intrinsic value was beyond doubt, which is still the case today. Just as gold has its place as a chemical element in the earthly periodic table and as a decorative element in the domes of various places of worship in the heavenly world, it also has a firm place in the investment universe.

Read more about financial markets

The quarterly publication Investorama is LGT’s magazine for investors. In it, you will find our experts’ analyses of current trends and developments in financial markets.

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