Gold occupies a unique position among assets, revered for its intrinsic value, scarcity, and historical perseverance. Unlike fiat currencies susceptible to inflationary pressures, gold’s limited supply makes it a preferred hedge against economic uncertainties. Its appeal as a safe haven asset has persisted throughout history, attracting investors during times of geopolitical turmoil, market volatility, and currency devaluation. As such, incorporating gold into a diversified investment portfolio can provide stability and defence against unforeseen market fluctuations.
Gold’s Correlation with Other Assets
Correlation measures the degree to which the prices of two assets move in relation to each other. Understanding how gold correlates with other asset classes helps investors gauge its effectiveness as a diversifier and its potential impact on portfolio risk and returns. The following is an overview of how gold typically correlates with other asset types:
Equities: Gold has historically exhibited a low to negative correlation with equities. During market instability, gold acts as a safe haven, attracting investors away from volatile equities. Conversely, during periods of strong economic growth and rising stock prices the demand for gold may diminish.
Bonds: Gold’s correlation with bonds is generally low or slightly positive. While bonds tend to be considered safer than equities, they can still be impacted by inflation and currency devaluation. Gold, serving as an inflation hedge and store of value, can demonstrate modest positive correlation with bonds during times of economic stress.
Cash (Money Market Instruments): The correlation between gold and cash equivalents, such as money market funds, is generally low or negligible. Cash provides stability and yield in high-interest rate environments, but minimal returns in low-interest environments. Gold, offering a hedge against currency devaluation and inflation, is an attractive alternative to holding large cash positions during economic uncertainty.
Property: Gold’s correlation with property can be impacted by macroeconomic factors and varies with market conditions. During economic downturns or housing market corrections, gold may show a positive correlation to property as they are both perceived as safe-haven assets to preserve wealth. However, in times of economic growth and rising property prices, gold’s appeal may diminish, and this correlation may weaken or turn negative.
Commodities: Gold is a commodity itself, but its correlation with other commodities can vary. Despite sharing characteristics like being a finite resource and an inflation hedge, gold’s price can also be influenced by unique elements which we shall explore in the following section.
Factors Influencing Gold Prices
While the price of gold has trended upwards over the long-term, it has also exhibited volatility. Several key factors influence the price of gold, shaping investor sentiment and market dynamics:
Consumer Demand: Gold jewellery represents the largest source of annual demand for gold per sector. This has declined over recent decades, but it still accounts for around 50% of total gold demand. India and China are by far the largest jewellery markets, together accounting for over 50% of the global total.
Investor Sentiment: Market sentiment and risk appetite can considerably influence gold prices. During uncertainty or fear, investors tend to flock to gold, increasing demand and prices. For example, recent surges in the trading volumes of gold futures contracts in Shanghai have been seen as reflective of Chinese private investors diversifying away from real estate amid the country’s ongoing property crisis.
Central Bank Policies: Central banks significantly impact the gold market through their buying and selling activities. We are continuing to see high levels of purchases by central banks, particularly in emerging markets, which has continued to strengthen demand and support prices.
Geopolitical Uncertainty: Political instability, conflicts, and trade disputes often increase gold demand as investors seek safety, driving prices higher.
Inflation Expectations: Gold tends to perform well in environments characterized by rising inflation expectations, as investors seek refuge from the erosion of purchasing power.
Currency Movements: As gold’s primary base price is U.S. dollars it can be affected by currency fluctuations. A weaker dollar typically translates to higher gold prices, and vice versa.
Gold Funds vs. Gold-Linked Equities
Retail investors are able to choose between collective investments which are directly linked to the movement in the gold price, or holding equity in companies whose revenues are derived from gold.
Gold-Linked Equities:
Gold Mining Companies – Purchasing shares of companies engaged in gold exploration and production can offer potential capital appreciation and dividends but come with company-specific risks like operational challenges and regulatory changes.
Gold Retailers – Given the large proportion of overall gold demand that jewellery represents, it follows suit that holding equity in jewellery retailers can also provide exposure to the gold price. However, as with miners, the additional operational, business, and market risks that come with owning any equity must also be considered.
Gold Funds:
Exchange-Traded Commodity Funds (ETCs) – ETCs provide simple exposure to movements in the gold price by either physically holding stockpiles of gold bars, coins, and bullion, or synthetically replicating the performance of the gold price through financial derivatives. Synthetic ETCs typically have lower costs but carry additional counterparty risk. Physically backed ETCs incur additional storage and insurance costs, but provide tangible security, transparency, and liquidity.
Unit Trusts – In addition to ETCs, gold exposure can also be accessed via unit trust structures. While these vehicles usually incur higher fees than ETCs, they involve an additional active management aspect with dedicated fund managers selecting the blend of physical and equity exposures they best see fit to benefit from the multiple variables that can influence the gold price.
Conclusion
Overall, while the gold price can be volatile with multiple surges and corrections over the short-term, gold’s relatively low correlation with traditional asset classes and historical role as a store of value makes it an attractive diversification tool for investors looking to mitigate portfolio risk and preserve wealth over the long-term. The optimal gold allocation may vary based on individual risk tolerance, investment goals, and market outlook. EFG Harris Allday’s team of Investment Managers can provide tailored advice for investors looking to include it in their portfolio.
The value of any investments can fall as well as rise, and the income derived from them may fluctuate. You might get back less than you invest. Currency exchange rate fluctuations can also have a positive and negative affect on your investments. Please note that EFG Harris Allday does not provide tax advice. Past performance is not a reliable indicator of future performance.