Why Does Gold Have An Eternal Appeal?

Why Does Gold Have An Eternal Appeal?
Why Does Gold Have An Eternal Appeal?
Deepika Asthana - 11 May 2020

During periods of high volatility or prolonged unidirectional moves, absolute performance can highly skew portfolio returns. This brings to fore the integral role that portfolio diversification and asset allocation plays in investing and long-term portfolio growth.

Every asset class and investment instrument carries with it a certain degree of risk and promise of return. However, since the sources of risk and return are different for each asset class, their response to macro-economic developments is also varied. This is why in similar investment environments; some asset classes will generate negative returns while others will generate stable to positive returns. By adopting an optimal asset allocation strategy, you can ensure that no event or macro-economic environment has an inordinate impact on your portfolio returns.

The role that alternative investments and specifically gold play in achieving optimal asset allocation.

The Global Financial Crisis (GFC) taught us that historical correlations can only go so far in helping us predict how asset prices respond to a particular environment. Additionally, it also revealed a new truth – in an increasingly globalised world, asset prices are more intertwined than previously envisaged. In an attempt to build diversified portfolios in the context of the ‘new normal’ and generate higher risk-adjusted returns, institutional investors across the world embraced alternatives to traditional stocks and bonds. The share of non-traditional assets among global pension funds increased from 7 per cent in 1998 to 26 per cent in 2018.

One of the biggest beneficiaries of this shift has been gold. Allocations to the yellow metal have only been increasing over the years with demand growing at an average of 14 per cent per year since 2001 and prices increasing by almost eight fold over the same period. Clearly, it has now become a mainstream investment asset. The following factors have contributed to its growth.

• Emerging market growth: growth in emerging markets like China and India gave a fillip to the demand for gold as an increasingly affluent population diversified gold’s consumer and investor base.
• Market access: one of the factors that deterred investors from buying gold was the high cost of physical storage. However, the launch of gold-backed ETFs in 2003 facilitated access to the gold market and made it easier for investors to hold the asset through a reduction in the total cost of ownership and increased efficiencies.
• Market risk: as previously mentioned, the GFC prompted investors to look at portfolio risk from a fresh lens and focus on effective risk management. Gold as an uncorrelated and liquid asset has attracted investor attention.
• Monetary policy: in a low interest rate regime, the opportunity cost of holding gold reduces significantly while highlighting its ability to be a source of genuine long-term returns.
• Central bank demand: a surge of interest in gold among central banks across the world, commonly used in foreign reserves for safety and diversification, has been instrumental in hoisting its demand.

In the current environment, gold can be a valuable addition to an investor’s portfolio considering it ability to reduce portfolio risk and enhance long-term portfolio returns.