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Five gold misconceptions that could reduce your returns

It’s believed that the first gold coins were minted in the ancient Kingdom of Lydia, located in what is now part of western Turkey, around 550 B.C. These coins were stamped as a guarantee of their purity and weight and since then almost every government has minted gold coins for currency.

Over the past 2,000 years, gold has continued its upward trajectory in terms of value and is still regarded as an item of wonder and beauty, whether that be as jewellery, collector coins or on the stock exchange as an exchange-traded product (ETP).

Investors and advisers struggle to justify buying gold

In 2012, reforms were introduced to the Corporations Act 2001 which included prospective bans on conflicted remuneration structures. This included commissions and volume-based payments, relating to the sharing of and advice about a range of retail investment products. This was due to the unregulated and somewhat unethical financial guidance given by advisers who only recommended commission-earning products.

The Financial Planners and Advisers Code of Ethics 2019 (FASEA, 2019a) states the following:

“Collectively, financial planners and advisers are members of Australia’s newest profession. As such, while they formerly provided a commercial service, they should be committed to offering a professional service -informed by a code of ethics intended to shape every aspect of their professional conduct.”

Prior to 2012, many advisers simply wouldn’t recommend gold as there was no incentive for them to offer it. Even after these regulations were introduced, the hangover still exists, especially with the notion that gold pays no dividends.

However, the idea that gold should be disregarded because of lack of return is perhaps an oversight. During uncertain periods like the ongoing Covid-19 pandemic or as the Russian/Ukraine war rumbles on, diversifying portfolios has never been more important. The idea that gold will not help mitigate risk in portfolios is a misconception.

Five common misconceptions about gold

We’ve pulled together the five most common misconceptions held about investing in gold.

1. Gold is too risky to be included in portfolios

There may be short-term volatility, but long term, it’s a different matter. Gold can be used to diversify portfolios to help risk-adjusted returns (risk adjusted returns are a calculation of an investment's return by looking at how much risk is taken to obtain that return). 

The table below illustrates that from 1970 to 2020, gold’s volatility was in line with equities. If investors had a 50/50 blend of gold and equities, the generally-negative correlation of gold to other traditional asset classes (stocks, bonds, cash and real estate) could significantly reduce portfolio volatilities. 

AUSTRALIAN EQUITIES AND GOLD 1970 TO 2020

According to the World Gold Council: 

“Gold is a clear complement to stocks, bonds and alternative assets for well-balanced … investor portfolios. As a store of wealth and a multi-faceted hedge, gold has outperformed many major asset classes while providing robust performance in both rising and falling markets.”

2. Investing in gold is only effective when inflation is high

Often, gold is only seen as beneficial during periods of high inflation. The 1970s oil crisis was one such time that hit the global economy hard, triggering a stock market crash and sending inflation rates climbing. With markets in turmoil, gold rose from a low of USD35 per ounce in 1971 (set during the gold standard) to a peak of USD180 in late 1974. By 1976, however, the gold price fell nearly 40% to USD110 before gaining again in 1978 and then hitting an incredible USD850 in January 1980.

The World Gold Council, covering market data since the 1970s, found that gold has on average delivered gains of 15.1% (in nominal terms) and 8.3% in real terms in the years US CPI has averaged 3% or more.

For local investors, analysis conducted by The Perth Mint suggests the gold price in Australian dollars has on average risen by just over 20% in nominal terms in years when the local CPI was 3% or higher. But even in the years where CPI was below 3%, gold has still returned a nominal average of 3.6%.

3. Gold does not provide long-term portfolio returns

Although gold has not outperformed stocks and bonds during various market patterns, it has provided positive returns over a longer term, comparative to many other asset classes.

Adding gold to a hypothetical Australian portfolio over the last 15 years would have increased risk-adjusted returns

LONG TERM ANNUALISED RETURN UNTIL END OF 2021

4. Without paying interest or dividends, gold has no value

It is indeed true that gold doesn’t provide income like some stocks and bonds. Instead, investors in gold are compensated solely by price appreciation, driven by economic and market trends. The chart below shows gold returns in AUD over the last 20 years.

GOLD’S ANNUAL RETURN IN AUD

Source: World Gold Council, The Perth Mint

5. Only when the US dollar declines does gold appreciate

Although the US dollar and gold have had a long economic tie, when the gold standard was abolished by US President Nixon in 1971, central banks were no longer entitled to on-demand conversion of their dollars into gold. Officially delinking gold’s price from the US dollar allowed the price of gold to be influenced by open market demand.

Factors such as demand, interest rates, inflation, central bank reserves, production and market volatility can all influence the return on gold, pushing the price of the precious metal up as well as down. In January and February 2020, when the COVID pandemic was taking grip, the US dollar and gold actually rose in price, having a positive correlation.

But it’s not all about the US dollar. Gold also offers a de facto foreign currency exposure in an Australian investor’s portfolio, with declines in the value of the Australian dollar typically magnifying the gains gold delivers to local investors. In periods of financial market stress, not only does gold tend to go up, but the AUD often falls. GFC is a prime example of this; in 2008, when USD gold price was +4%, AUD gold was +28%.

By complementing investments in bonds, stocks and broad-based portfolios, gold can hedge against currency depreciation and inflation, and has historically provided positive returns as well as offering liquidity in periods of market turbulence.

 

Sawan Tanna is the Treasurer of The Perth Mint, a sponsor of Firstlinks. The information in this article is general information only and should not be taken as constituting professional advice from The Perth Mint. You should consider seeking independent financial advice to check how the information in this article relates to your unique circumstances. 

For more articles and papers from The Perth Mint, click here.

 

14 Comments
David
July 18, 2022

I probably overstated the case, but bear in mind that the jewellery trade absorbs only about half the new gold mined each year. I personally would like to see the return of money made out of precious metals as it was 100 years ago. I have no faith in fiat currency or central banks at all and would like to see all that disappear. Probably won't happen. Far too many vested interests and loss of power of the insiders.

David
July 17, 2022

Australia is close to being the number one gold producer in the world. The value of gold in $US terms has plumetted in recent months. If the $US is losing purchasing power by 10.5% pa. gold is losing it at about double the rate. However in $A terms, gold has barely budged in value, as the $A is falling to keep gold almost steady around $2500 /oz. In the USA, gold is not doing what is expected of it, namely a hedge against inflation. When Keynes rejected gold currency, he thought that it was unlikely that new finds of gold would keep up with demand, but in fact gold production, with modern technology has kept pace with human poulation growth over the past century. Demonetising it has relegated it to being somewhat useless. You can't eat it, or put it in your car tank. King Midas found it had many disadvantages. The biblical parable of the talents is a good guide on investment.

C
July 17, 2022

Not useless. Jewelry is a multi billion dollar worldwide industry. My wife has contributed to it !
You can't eat clothes or put clothes in your car tank either.
It also happens to be one of the very best conductors of electricity, better than copper, and is used as such in some high end equipment.
It would be the standard for electrical conduction instead of copper if it weren't so damn expensive.
Therefore wrong to say gold is useless

C
July 17, 2022

Correction to my statement. Gold is no more electrically conductive than copper but is much more inert ( non corrosive ) and is the most ductile and malleable of all metals , physical properties which make gold very useful and it would be heavily used in electronics and other industries if it weren't so expensive. Unlike other metals, gold never tarnishes or corrodes and lasts virtually forever

Dudley
July 14, 2022

Gold was / is useful for transporting an emergency fund where the banking system does not provide that function - such as during a period of political or economic instability. Nations and individuals have / do use it thusly.

A modern use is to travel carrying a few bullion coins in case debit / credit cards are stolen / stop working.

Cost of extraction of gold continues to increase as ores reduce in concentration.

So long as there are sufficient nations / individuals wanting to have a an independent emergency fund, gold price will rise.

Richard Brannelly
July 14, 2022

I actually tried reading this with an open mind but when Sawan starts with some unjustified adviser bashing my blood pressure went straight up. I'll set aside his own clear conflict of interest and explain for the record why as an adviser I have never recommended gold or any other inanimate commodity;
1. It produces zero income and will forever produce zero income
2. The speculator is subject to transaction and ongoing holding costs
3. The only chance of generating a positive return relies on the greater fool than though theory (apologies to Peter Thornhill for stealing his line)
4. By definition I consider all commodities trading as a speculative undertaking and NOT investing.
There are a whole bunch of other serious compliance, research, and professional indemnity insurance issues impacting professional advisers considering recommending gold - but ultimately I just focus on investments that put cash in my trusting clients pockets, rather than speculative assets that take cash out of their pockets. Hardly the same incentive as Sawan incorrectly focuses on?

Fred
July 14, 2022

Absolutely glad I am not your client and never will be.

Kevin
July 14, 2022

I agree with you Richard.However people can accept or reject the article.I'm not sure if you can still make money through lending gold to people that want to short it but that just complicates it more.

1919 gold @ US$35,Coca cola share @$40.Look at the difference now,around 10,000 shares in coke at $50 (?) each plus all the dividends collected over the 100 years.You'll be accused of cherry picking.

1980 gold hits top of $850,the Australian index starts @ 500.Gold is at whatever it is,the index is at 7000 (?) plus all the dividends,minus costs.The accumulation index is $80,000 ( ?) ,minus costs.

What shall we do tomorrow ,$2500 into super,or a single company,or an ASX 200 ETF,it seems a no brainer to me.
People see what they want to see and hear what they want to hear.Whatever they want to see is real,and it can never be questioned .

Kevin
July 14, 2022

Got curious and googled ,I think the ticker is KO ( coke).Closed at US$62.38.Price at 16/7/1982, 79 cents,I take it that is split adjusted.I wonder why that Buffett fella bought coke and not gold.I think he is quite famous for that choice after the 87 crash.

Mic Smith
July 14, 2022

Pretty vicious response to admittedly a Perth Mint puff piece. However Financial Planners (presumably Ric is one) are hardly justified in preaching a story of wholesome and unconflicted advice.

C
July 17, 2022

Shares in Berkshire Hathaway give investors no income either.

Kevin
July 17, 2022

I don't know what you mean by that.Internal companies within Berkshire pay dividends.They are reinvested thus Berkshire goes from $7 a share in 1965 to $400K now.

Amazon doesn't pay dividends,the splits take 1 share in Amazon ( 2 for1, 3 for 1, 2 for1 and 20 for 1) to 240 shares in AMZN. 240 shares in AMZN are roughly US$ 25K.I think the IPO was $20 but check that .

Are you expecting gold to grow at these rates? Correlation is causation?

Dividend income grows BRK A in size and reinvested profits or debt grow Amazon in size. Gold goes up and down in price.

Wildcat
July 14, 2022

Under what basis does Sawan make the claim "many advisers simply wouldn’t recommend gold as there was no incentive for them to offer it". This is simply a wild assertion without providing any basis for the claim. We have been using gold as a portfolio hedge for years. We are also not unusual.

Shaun
July 15, 2022

I am really surprised that a financial planner would outright disregard gold as a portfolio hedge. For example, during the 1970s, 1940s, and WW1 a retiree would have lost a considerable amount of purchasing power if their portfolio was only located in shares and bonds. In the long run, shares have done well, but inflation can destroy a portfolio that someone needs to live on and nominal bonds can be a death nail during high inflation.

 

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