Portfolio diversification through gold- adding more than just glitter

  • Low cost of physical storage — gold is a high-value investment; therefore, its storage costs are much lower than those of other commodities that need large spaces to store very large investments. At USD2,000/oz, a USD1bn investment would buy only around 15.6 tonnes of gold but around 100,000 tonnes of copper at USD10,000/t; far more would be required to store other metals or agri commodities. One possible solution is to invest in commodities using futures (such as on the Reuters CRB Index or the Bloomberg Commodities Index), where commodities need not be physically stored; however, the rolling cost (premium + transaction cost) at the expiry of contracts is usually very high and drags down overall returns significantly.
  • Diversification — industrial commodities, including metals, energy and agri, share a direct relationship with economic growth and usually move in line with equities. Investors looking to diversify their assets may find portfolios less diversified even after including the broader commodity index. On the other hand, gold has a negative correlation with equities due to its safe-haven appeal and helps investors in the optimal diversification of portfolios.
  • Hedge against inflation — with key interest rates at ultra-low levels, inflation has been spiking, likely to drive higher investments in gold that acts as a hedge against inflation, especially during periods of high inflation. As the value of fiat currencies falls sharply, investors turn to safe-haven assets such as gold to protect the purchasing power of investments.
  • Geopolitical risks — a number of countries, especially Russia and Ukraine, the Middle East and the countries involved in the South China Sea dispute, face growing geopolitical risks. Governments, central banks and investors tend to prefer gold during uncertain times. Any short-term escalation in geopolitical risks, such as that in recent weeks relating to Russia and Ukraine, could push demand for gold significantly higher and generate a good return for investors in the metal.
  • Limited supplies — gold mining production increased at a moderate CAGR of around 2.2% per year over the past decade to around 3,561 tonnes in 2021[2]. Gold mining is a profitable business but not very lucrative, limiting its appeal to attract substantial investments in the immediate term. Additionally, labour issues in gold mining and depleting reserves make it difficult to increase production significantly in the long term.
  • Availability of investment vehicles — investment in gold has historically been via purchasing jewellery, especially in Asian countries such as China and India, largely on account of the ease of transaction; however, this has added to the cost of gold procurement (fabrication charges and adulteration) and reduced the realised rate of return for investors in the short to medium term. However, with new investment vehicles (such as ETFs or gold bonds) increasingly available to retail investors, investment in gold is likely to remain strong over the next decade.

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We write about financial industry trends, the impact of regulatory changes and opinions on industry inflection points. https://www.acuitykp.com/

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Acuity Knowledge Partners

Acuity Knowledge Partners

We write about financial industry trends, the impact of regulatory changes and opinions on industry inflection points. https://www.acuitykp.com/

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