What makes gold a strategic asset?

Gold benefits from diverse sources of demand: as an investment, a reserve asset, jewellery, and a technology component. It is highly liquid, no one’s liability, carries no credit risk, and is scarce, historically preserving its value over time.

How to value gold for maximum portfolio impact

Gold does not directly conform to the majority of the most common valuation methodologies used for equities or bonds. Without a coupon or dividend, typical models based on discounted cash flows, expected earnings, or book-to-value ratios, struggle to supply an appropriate assessment for gold’s underlying value. This presented an opportunity for the World Gold Council to develop a framework to better understand gold valuation. 

What is the Gold Valuation Framework (GVF)?

GVF is a methodology that allows investors to understand the drivers of gold demand and supply and, based on market equilibrium, estimate their impact on price performance. GVF powers our web-based tool, QaurumSM, which allows users to assess the potential performance of gold under customisable hypothetical macroeconomic scenarios provided by Oxford Economics.1
 

Macro drivers

 

Our analysis shows that the price performance of gold can be explained by the interaction of four key drivers:

  • Economic expansion: periods of growth are very supportive of jewellery, technology and long-term savings
  • Risk and uncertainty: market downturns often boost investment demand for gold as a safe haven
  • Opportunity cost: the price of competing assets, especially bonds (through interest rates) and currencies, influences investor attitudes towards gold
  • Momentum: capital flows, positioning and price trends can boost or dampen gold's performance.
     

 

Focus 1

 

For more information on long- and short-term drivers of gold, visit the data section on Goldhub.com.

Gold can enhance a portfolio in four key ways:

Returns

Diversification

Liquidity

Portfolio performance

Inflation, supply-chain concerns and COVID uncertainty remain at the forefront for investors in 2022.?

Inflation was a prominent global theme throughout 2021 and is still a key input into 2022 investor decisions. While many central banks (CBs) felt the uptick in inflation levels was temporary on the back of COVID’s impact in the first part of 2021, this consensus shifted in the latter part of the year. Some CBs now acknowledge that inflation is here to stay for longer and are expected to raise rates in 2022. Conversely, other countries like China, India and the ECB are expected to continue accommodative policies.

Meanwhile, supply chain bottlenecks caused by the pandemic have not fully dispersed. It is true that governments proved reluctant to respond to the recent spike in COVID cases with formal shutdown measures of the sort that disrupted economic growth over the last two years, but new variants could change this behaviour, and a resurgence of supply chain disruption – across multiple sectors from technology to shipping – could negatively affect economic growth and create additional inflationary pressure.

While the market expects rates increases and a strong US dollar — a negative for gold price performance — real and nominal rates should remain at historically low levels.

Our analysis shows that gold has performed well into CB hiking cycles and has been an effective inflation hedge. Coupled with healthy jewellery and CB demand, and the potential for market volatility in a vastly changing world, the strategic rationale for gold in a portfolio — particularly as a portfolio hedge — remains compelling (see 2022 Gold Outlook).

ESG considerations

Over recent years, investors have increased environmental, social and governance (ESG) considerations as part of their investment process. For example, in a MSCI survey of 200 institutional investors managing around $18 trillion, 73% planned to increase ESG investment in 2021,2 and in a survey of 800 individual US investors by Morgan Stanley in October 2021 79% were focused on prioritising sustainable investing3. This increased emphasis on ESG reflects growing pressure for businesses to actively watch and manage ESG risks. It also supports the position that good ESG performance can lead to better long-term financial performance.4?The shift towards a greater integration of ESG objectives within investment strategies has important implications for gold, which investors expect to have been responsibly produced, and can play a role in supporting ESG goals and managing associated risks within a portfolio (Focus 2: Gold as an ESG investment).5

?

The increased relevance of gold

Institutional investors6 have embraced alternatives to traditional investments such as equities and bonds in pursuit of diversification and higher risk-adjusted returns. For example, the share of non-traditional assets, such as hedge funds, private equity funds or commodities, among global pension funds increased from 7% in 1998 to 26% in 2020 – this figure is 30% in the US.7

Gold allocations have been recipients of this shift. Investors increasingly recognise gold as a mainstream investment; global investment demand has grown by an average of 10% per year since 2002 and the gold price has increased almost seven-fold over the same period.8

?

Our analysis illustrates that adding between 4% and 15% in gold to hypothetical average portfolios over the past decade, depending on the composition and the region, would have increased risk-adjusted returns.9

 

Chart 1: Gold allocations can increase risk-adjusted returns across global average hypothetical portfolios

Gold allocations can increase risk-adjusted returns across global average hypothetical portfolios

Range of efficient frontier gold allocations for average investment portfolios in respective regions*

Gold allocations can increase risk-adjusted returns across global average hypothetical portfolios
Range of efficient frontier gold allocations for average investment portfolios in respective regions*
*The solid bars represent the optimal range of gold for an average hypothetical portfolio in each region. The marker represents the allocation to gold with the highest risk-adjusted returns. For specifics on each region’s portfolio makeup, please see Charts 13, 14a and 14b and important disclaimers and disclosures at the end of this report. Source: World Gold Council

Sources: World Gold Council; Disclaimer

*The solid bars are the optimal range of gold for an average hypothetical portfolio in each region. The marker represents the allocation to gold with the highest risk-adjusted returns. For specifics on each region’s portfolio makeup, please see Charts 13, 14a and 14b and important disclaimers and disclosures at the end of this report

 

Gold performance has been strong in recent decades, supported by key structural changes

Gold performance has been strong in recent decades, supported by key structural changes

Gold performance has been strong in recent decades, supported by key structural changes
Sources: World Gold Council

Sources: World Gold Council; Disclaimer

Footnotes

1Oxford Economics is a leader in global forecasting and quantitative analysis and a specialist in modelling. Visit Qaurum for important disclosures about Oxford Economics’ data, as well as a detailed description of the available scenarios; the assumptions underlying and data used for each scenario; and its respective hypothetical impact on gold demand, supply and performance.

2MSCI Investment Insights Report 2021

32021 Sustainable Signals Individual Investor, Morgan Stanley, January 2021

4Refinitiv, How do ESG scores relate to financial returns, August 2020.

5Gold and climate change: Current and future impacts, October 2019.

6An institutional investor holds and/or manages assets for clients in larger, pooled portfolios often represented as mutual funds, banks, brokerages, hedge funds, etc.

7Willis Towers Watson, Global Pension Assets Study 2020, February 2020 and Global Alternatives Survey 2017, July 2017.

831 December 2001 to 31 December 2021.

9See Chart 13 for more details behind the composition of the hypothetical regional portfolios. Based on 2001 – 2021. In addition, refer to important disclaimers and disclosures at the end of this report.

Important disclaimers and disclosures [+]Important disclaimers and disclosures [-]