Gold As An Investment
Gold and Other Commodities
Commodities can be broken down into 3 main broad categories:
Agricultural – includes grains, oilseeds, livestock, dairy, lumber, textiles and softs (cocoa, coffee, sugar etc)
Energy – includes crude oil, natural gas, coal and their by-products
Metals & Minerals – includes precious metals, base metals and ores
Gold is one of the most effective commodity investments because of unique characteristics that differentiate it from other commodities:
– Gold has delivered better long-term, risk-adjusted returns than other commodities (World Gold Council)
– Gold is a more effective diversifier
– Gold outperforms commodities in low inflation periods
– Gold has a lower volatility
– The precious metal is a proven store of value
– Gold is one of the most liquid physical commodities
– Unlike many commodities, it’ is not consumed and itsit’s not perishable
When compared to other commodities, gold has outperformed not only broad-based indices but most individual commodities too.
Gold and Other Financial Assets
In the investment world, other financial assets can be categorised in many ways. Broadly speaking they can be broken down simply as follows:
– Public equity – stocks traded on stock markets
– Debt – supranational, government and corporate
– Real Estate – all forms of property and land
– Alternatives – private equity, hedge funds, private debt to name but a few commodities
The key to successful investing is managing your risk, understanding your personal goals while understanding your constraints. This is especially true in times of market risk, uncertainty or recessions. While stocks pay dividends and bonds pay interest, gold doesn’t provide a nominal return unless the price rises.
That said, gold’s performance in the 10 years between 2006 and 2016 outperformed the FTSE 100, 10 & 20 government bonds, UK property, savings accounts and inflation. It’s clear to see that when uncertainty hit its highest point in 2008 – when the markets crashed, sending equities and real estate plummeting – gold increased in value significantly.
And that isn’t a one-off occurrence. In August 2018, the FTSE 100 lost £36bn in value in one day, about 2% of its total value in its largest fall since 2008. In that same period, gold increased by 3%. This was driven by investors removing their exposure to equities and instead purchasing physical gold.
According to the World Gold Council, gold as an investment has performed broadly in line with the S&P500 over the long term, delivering average annual returns of 10.4% since 1971.
Gold is also sensitive to global geopolitical issues. While these events could have a short-term impact, they can have a significant effect on gold prices. For example, it’s not uncommon for gold prices to rise as a consequence of global unease: whether that’s a missile test in North Korea, tensions in the Middle East intensifying, or trade wars between two of the world’s largest economies. Gold is the ultimate safe-haven asset: in times of uncertainty, investors flock to it.
The Gold/Silver Ratio: History and Mystery
Historically, the gold/silver ratio was a huge part of everyday life. Why? Because for centuries, people minted coins directly from both gold and silver. To know what their money was worth, everyday people needed to know the math. They also wanted to know how much of the shiny stuff was on the Earth.
In places without domestic silver mines, such as ancient Egypt and medieval Japan, the ratio skyrocketed, making silver much more valuable than gold. Over time, the growth of the global market eased the ratio and improved the balance of gold and silver across the globe.
The ratio describes how much silver is required to buy an ounce of gold. If the ratio is at 50 it means it takes 50 ounces of silver to buy one ounce of gold. It is the gold price divided by the silver price.
Of course, the ratio itself has been fairly volatile. The ratio has also seen several dips and surges resulting from more general financial crises and recoveries. It is important to note that the ratio should be monitored but that it is part of a far broader array of investment research that is required when investing in precious metals.
First of all the silver market is far smaller and less liquid than the gold market. This means it is more volatile. Second, because of this relative illiquidity silver tends to overshoot and undershoot during phases of market stress or change. Because silver has far more industrial uses than gold it is considered to be more cyclical, and this more correlated to the overall health of the economy. Demand for silver can suddenly drop off in periods of recession but quickly accelerate higher in times of recovery or growth. gold on the other hand has more defensive attributes as a safe haven which usually override the drop in jewellery demand during recessions.
Monitoring the ratio can give clues to where the economy and markets could go but as stated before it must be considered within a broader remit of research and due diligence when investing.
Gold to Silver Ratio – 100 Year Historical Chart
Different Strategies of owning gold
There are a variety of methods to diversify your portfolio with gold. All them depend on your individual circumstances
Gold can play a significant part in an investment portfolio. Gold’s historically low correlation to other asset classes can help portfolios perform better during times of uncertainty.
Keeping yourself informed about the demands of markets that consume gold is another way to predict the increase in value. You can sign up for Goldex’s market news which will keep you informed.
For many people “dollar cost averaging” is the preferred strategy to accumulate gold. First of all, investors should understand their investment needs and constraints within their whole portfolio as well looking at their risk tolerance, age, financial situation and liquidity needs. Once this has been ascertained, and the decision to allocate to gold has been made, many investors prefer to avoid trying to time the market and simply buy gold at regular intervals throughout the year.
On the other hand, some investors prefer to trade gold on a shorter-term basis. This could involve looking at technical analysis, examining monetary policy and political news and deciding how much to invest in trade, how to execute and what stop-loss or price targets exist.
Furthermore, some investors do both. This is called “trading around a core position”. For example, an investor would have a range of his whole portfolio of 10-15% allocated to gold. If they were fully invested at 15% and thought the price had moved too high they could reduce it to 10% by selling gold, and then waiting until it came back in price and increasing it again to 15%.
Dual Properties of Gold
Gold is an important diversification tool with key properties that come into their own during periods of systemic risk.
While gold has little correlation with many other assets – including many other commodities – it is usually positively correlated with stocks during periods of growth (when equity markets tend to rise). However, gold is usually negatively correlated with other assets during ‘risk-off’ periods protecting investors against risks and other events that can have significant impacts – protection not always present in other commodities.
The dual nature of gold as both as an investment and a consumer good plays a role in this. When economic conditions are benign, expenditure tends to increase on items like jewellery or tech devices, and this works in gold’s favour. During times of risk, investors look for safe havens, which can also benefit gold investment and drive up prices.
Diversification Across Asset Classes
If you don’t diversify your portfolio – meaning, you invest all your money in one place – you’ll have full exposure to the risks of that particular investment. For example, an investor with a £10,000 portfolio might have chosen to invest their money in a single company’s stock. If that company were to suffer a setback of some kind – like a profit warning, or a key stakeholder resigning – their share value might fall, and this would negatively impact your entire portfolio.
Some investors might choose a number of stocks or put their money into an investment fund that does this for them. This can reduce risk, especially if the stocks are varied between industries and geographical locations, but still carries an overall market risk as many investors will remember during the financial crisis of the late 2000s. A diversified portfolio of stocks will still go down significantly during a crisis.
Effective risk diversification requires investments made in wholly differing markets; which will respond to different influences. By doing this, if one part of a portfolio underperforms, the others will either maintain values or potentially grow, countering the loss in an ideal situation.
One of the best ways of ensuring a diverse portfolio is to invest in vehicles with negative correlation; some markets will do well when others struggle. Even if not a like-for-like correlation, by having some level of opposing performance, your money should have a degree of protection.
Precious metals such as gold are considered excellent ways to diversify a portfolio of any size. Gold especially is considered a hedge against inflation, and inflation is one of the key risks for economy-based investments like stocks or ISAs. Gold is also a safe-haven asset; when other markets crash, gold typically sees its value increase.
It’s recommended by many experts to diversify your investment portfolio with gold so that the precious metal makes up anywhere between 5 and 10% of your total portfolio value. Depending on your situation and your risk tolerance, you might be more comfortable with a bigger or smaller share of gold in your portfolio. Ultimately, your portfolio should be structured in a way that helps you reach your long-term goals.