As US-China trade tensions rumble on and threaten to throw a shadow across the across the global economy, investors have been turning to gold to protect their portfolios. The price of the yellow metal has climbed to levels not seen since 2013 and European Gold Exchange-Traded Commodities (ETCs) saw their largest net inflows for more than five years in June. But is now the time to add a small gold exposure to your portfolio?
The Case for Yellow
Within the spectrum of potential investments, gold stands apart. For centuries relied upon as a store of value in turbulent times, it holds little economic value and provides no cashflow. These unusual characteristics make gold difficult to value using traditional financial models. But the metal is widely considered a barometer for investor sentiment, with demand peaking in times of market distress and falling away in times of relative calm.
A low, and often negative, correlation with other asset classes makes it a desirable addition to an existing portfolio of stocks and bonds. This is because according to financial theory, adding imperfectly or negatively correlated assets to an existing portfolio will improve diversification and boost long-term risk-adjusted returns.
In this case, falling gold prices in booming markets may dampen portfolio performance but the potential gains in bear markets can offset tumbling prices elsewhere, smoothing returns.
To see this in action we need only look at the 2007/08 global financial crisis: as global equity markets plunged by 48.3%, the spot price of gold rallied by 35.8%. Performance has been reversed in the ten years since then, however, with the MSCI ACWI index outperforming gold cumulatively by more than 200%.
Risk-Adjusted Returns
To demonstrate how the addition of gold to a stock and bond portfolio can improve risk-adjusted returns, we created a simple theoretical diversified stock and bond portfolio consisting of 60% MSCI World index and 40% Bloomberg Barclays Global Aggregate Bond Index. We will call this Portfolio A.
We then duplicated the portfolio and added a 5% gold holding - this is Portfolio B.
Finally, we simulated the performance of both portfolios and compared them. The "golden" Portfolio B posted a higher risk-adjusted return than Portfolio A over 5, 10 and 15-year periods. This is despite Portfolio A outperforming in absolute returns over both 5 and 10 years.
This indicates that adding gold to your portfolio can indeed bring welcome diversification benefits over long periods. As a note of caution, however, gold has exhibited a higher volatility than broad equities and is therefore best used as a small part of a wider portfolio.
How to Invest in Gold
The most straightforward way of buying gold is to directly purchase bullion or coins. But while this approach may be satisfying, the transactions costs, liquidity constraints and security costs are generally prohibitive.
The most popular alternative is to invest in a physically backed exchange-traded commodity (ETC). As the name suggests, these products use invested funds to directly buy gold, which is stored in a secure facility. This structure has a pleasing simplicity and given the commodities role as ‘armageddon insurance’, it is reassuring for many investors to know that their investment is physically underpinned by registered bullion.
As always, the first port of call when evaluating which passive fund to choose from is the management fee.
Currently the cheapest gold ETC listed on the LSE is the ETFS Physical Swiss Gold ETC (SGBS), which slashed its annual fee from 0.25% to 0.19% in July 2019. As the name suggests, an investment in this product is backed by physical gold stored in vaults in Zurich. It has tracked the spot price of gold closely since inception and is currently the stand-out option for UK retail investors.
Those who would rather have their gold stored closer to home can consider the iShares Physical Gold ETC (IGLN), which invests in bullion stored in London. While this ETC remains several basis points pricier than the ETFS Physical Swiss Gold ETC, it remains a solid alternative.
Worth a mention too is Gold Bullion Securities ETC (GBS). While this product has a high annual fee of 0.4%, it does come with an eye-catching benefit: investors in the ETC can withdraw funds directly in the form of physical gold coins. While this is a pleasing option to have, the associated costs mean that only under exceptional circumstances should an investor choose to exercise this right.
