All that glitters…

Gold has been one of the best performing assets these last two years, rising more than 40 per cent and even outpacing the S&P 500 index in the US.

Long regarded as a safe-haven asset, it is traditionally favoured by those worried about the health of the global economy and financial system.

However, gold has also proven to be a useful diversifier, making it a candidate for inclusion in mainstream investment portfolios.

For centuries, it’s been considered a store of wealth, holding its own through economic cycles, geopolitical stresses and other upheavals.

Gold attracts attention during periods of uncertainty, when investors are looking for a hedge against traditional assets.

Unlike paper or fiat currencies (which are government-issued and not backed by anything), it is a tangible asset that isn’t tied to any one economy or government.

Policymakers don’t control its supply, nor can they print more of it or erode its value.

It often shines during periods of higher inflation, such as during the 1970s.

Shares, bonds and real estate couldn’t keep up with rampant price increases, and investors went backwards in “real” terms.

Gold was one of the few things that performed well, with prices surging 14-fold over the decade.

Having said that, gold was more subdued during 2021 and 2022, when US inflation spiked above six per cent for the first time since 1990.

That could’ve been due to global shares roaring higher, at least for part of that period. When investor sentiment toward other asset classes is so high, it has less appeal.

Lower interest rates are also supportive for gold, especially the “real” interest rate (which is the interest rate less the inflation rate).

Unlike shares, bonds or property, gold doesn’t offer investors any income.

When interest rates are low or falling, the opportunity cost of holding a non-yielding asset like gold decreases and makes it more appealing.

Weaker currencies also have a positive impact on the gold price, particularly the US dollar which is the benchmark currency for gold pricing.

These last two points might partly explain its strong performance of late.

Central banks are cutting interest rates for the first time since the pandemic, and the US dollar has been slipping from the 20-year highs it reached in late 2022.

If we take a longer term view, we find that gold has delivered an annual return of 6.4 per cent (in NZ dollar terms) over the past 30 years.

That’s ahead of domestic fixed income at 6.0 per cent, but behind domestic and international shares have produced annual returns in the 8-9 per cent range.

Gold has been more volatile than those traditional asset classes, while negative returns have come more frequently.

However, if you take a typical 60/40 portfolio (with 60 per cent in shares and 40 per cent in fixed income) and add a small allocation to gold (let’s say five per cent), the results are interesting.

The return over that 30-year period increases marginally, while volatility falls and the weakest 12-month period improves.

It’s golds tendency to move in the opposite direction to other assets that makes it a useful diversifier.

While that’s not always the case, it often is during rough periods.

The three worst years for a typical portfolio in recent decades have been 2022, 2008 and 2002, all of which came in the wake of US recessions.

Your typical portfolio would’ve fallen about ten per cent in each of those calendar years, give or take.

In contrast, gold (in NZ dollars) went sideways in 2002, rose 40 per cent in 2008 and was up seven per cent in 2022.

If you’re considering gold, my advice would be to think of it as a component of a portfolio rather than a standalone investment.

It’s not a must-own, it doesn’t provide any income and it isn’t without risk.

However, a small allocation can make sense, providing additional diversification and reducing overall portfolio volatility without a significant impact on returns.

I like to think of gold as an insurance policy, rather than an investment.

I’m happy to own a little, whilst also hoping it doesn’t perform very well (as that might well mean the rest of my portfolio isn’t).

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