Gold is Best Performing Asset Class Over 6 Months, 1, 3, 5, and 10 Years

London – Over the most recent ten year period, in UK terms gold has outperformed its nearest competitor (bonds) by over 240%.  As investors have paid the penalty for increasing risk exposure over the period, the presence of gold in a portfolio matrix has boosted returns into positive territory.  Meanwhile ETF investment outstripped coin and bar demand last year.

At a recent presentation the senior analyst at ETF Securities produced a series of analyses that underpin gold’s role as a hedge against risk and he was able to show that, not only has it been a hedge against risk in the recent – and medium term – past, it has for much of the time been the strongest performing asset class. 

One of the quotes that ETF Securities likes to use regularly is this from Federal Reserve Chairman Bernanke; “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars it wishes at essentially no cost”. 

This is seen as particularly relevant recently given the problems in the euro zone and the argument is given further strength by the fact that the official sector appears to be voting with its feet.

The body of the presentation included the following demonstrations.

RELATIVE PERFORMANCE

Over the past ten years, gold has outperformed the next best asset class by a factor of just over two. Its outperformance against equities has been consistent over past one, three, five and ten years and for that matter gold has also been the least volatile asset class.  Its correlation with equities has remained zero or modestly negative, giving strong portfolio diversification.  On an average monthly return basis gold tends to outperform when equities perform poorly.  The presentation contained a fascinating table showing relative performance of different sterling based asset classes in each year from 2002 onwards and also showed that over the past ten years gold’s annual return has been 14.3% in sterling terms, compared with 5.9% pa from bonds, 1.6% in cash and just 1.2% in real estate.  Equity returns were negative.

PORTFOLIO ENHANCEMENT

Over the same ten year period, equities and bond portfolios have had a downward slope over past ten years, penalising investors for taking on extra risk.  Adding gold to the portfolio has rendered the return positive – also the other precious metals, but gold especially so.  Thus gold acts as a buffer for portfolios in times of high economic uncertainty. 

A SALVE IN TIMES OF UNCERTAINTY

During periods of high inflation gold returns are commensurately high, though the relationship is not strong when inflation is “normal”, i.e. 1 – 5%.   Currently there are growing concerns about future inflation, with US base money growth surging;  last year it increased by over 100% and historically there is a strong lagged relationship between inflation and base money growth.

Furthermore – gold is often thought of as a US dollar hedge and typically there is an inverse correlation.  Note now, though how the relationship has been positive as confidence wanes in the viability of the euro as a credible alternative reserve currency.

THE FUNDAMENTALS AND ETF FUND PERFORMANCES

While there have been outflows from the ETFs in the recent pullback in the gold price from over $1,200 to well below that level, there has been a very marginal decrease overall.  Outflows over past couple of weeks have coincided with price falls, but the redemptions, especially when compared with the strong performance in the early part of the year, have been small at just 1% of total.  Conversations with institutional holders have shown that these investors are staying loyal to their holdings, driven by the increased levels of uncertainty about international economic and fiscal conditions.  These investors are in for the long haul.

These drivers, especially high government debt levels, point to gold as a hard currency, and a hedge against risk.  By way of illustration, while credit default swap spreads have pulled back recently, they remain high.

FROM A FUNDAMENTAL STANDPOINT:

Only 60% of annual demand is met by new mine supply, with the balance coming largely from recycling.  In 2009 secondary supply accounted for roughly 40% of gold supply- aided particularly by high prices – with the official sector swinging away from persistent sales and becoming a buyer.

ETF Securities asserts that there has been increased interest developing in jewellery market recently at prices below $1,200, after scrap sales above $1,200.  This is helping to provide something of a floor, especially as jewellery demand accounts for roughly half gold demand in 2009 [but this is an anomalous year as a result of high prices and economic distress; from 1999 – 2008 jewellery accounted for an average of 76% of demand].  Coins and bars have taken up the slack and been the key driver of spot prices recently.  This time a year ago, investment commentary suggested $1,000 was the level where jewellery tailed off, but now it’s coming back in at $1,100-$1,200 as consumer resistance adjusts.

ETF DEMAND HAS BEEN AN INCREASINGLY IMPORTANT DRIVER IN THE MARKET

ETF gold demand outstripped coin and bar investment in 2009 for the first time.  It accounted for 10% of investment demand in 2003, but was roughly half the total in 2009, underlining how ETF investment is becoming increasingly important both as a price maker and price taker.

Meanwhile the official sector could be seen as a new source of demand.  Inventory rundown by developed economy central banks has slowed substantially, while there is a growing appetite from some emerging market central banks.  Give the medium to longer term uncertainties over sovereign debt crises and potential inflationary pressures, this is unlikely to change much in the future and this is a fundamental shift in the dynamics of the market.