VANCOUVER (miningweekly.com) – Gold is a proven store of value, especially for its role in safe-haven investment in times of geopolitical crises, but according to new analysis from the World Gold Council (WGC), the yellow metal plays a critical role in portfolios with exposure to emerging markets (EM).
The WGC notes in its latest ‘Investment Update’ that economic growth is a key driver of gold demand, especially in EM countries where there is a high affinity for gold as jewellery and investment. At the same time, gold tends to perform well in periods of crisis.
The WGC believes gold’s safe-haven investment and value preservation qualities are highlighted during extreme systemic events. Its price has historically increased during financial crises, including some linked to EM jurisdictions.
The WGC argues that having a strategic position in gold helps to improve EM portfolio performance as it can be used to capture EM upside through gold’s link to rising incomes; protect against systemic risks, which reduce portfolio volatility and losses – producing gains in some systemic sell-offs; and hedge foreign-exchange risk at a lower cost than traditional currency hedges.
The report notes that gold investment has a dual role in portfolios. Because gold gives a US investor’s EM portfolio positive correlation in a rising market and negative correlation in a falling market, gold has a dual nature for investment purposes – this quality is not seen in other traditional hedges.
Gold has performed well over time with returns on pace with the S&P 500 over multiple time periods. “It is not simply a hedge that eats into net returns, but it also provides the diversification for investors during strong and weak market environments,” the report found.
The WGC says EM investments have a “tremendous amount” of potential to continue growing and play a critical role in an investment portfolio. This is supported by global economic growth, which tends to have an incremental effect on performance in emerging versus developed countries.
Further, nearly two-thirds of global gold demand comes from emerging markets. Over the long run, income growth is a key driver of gold demand, especially in EM countries such as India, where there is an affinity for gold. Having gold exposure in an EM portfolio, therefore, couples with the EM exposure itself, the WGC points out.
“Adding gold to an EM portfolio produces higher absolute and risk-adjusted returns than a fully hedged or unhedged EM portfolio,” WGC analyst and report co-author Adam Perlaky says in the commentary.
Choosing whether to hedge the foreign currency or systemic risk of an EM portfolio is a critical decision for a US investor. Regardless of the decision, having some gold exposure provides a clear advantage for risk-adjusted returns compared with a portfolio with no gold exposure.
The WGC ascribes gold’s advantage as a foreign exchange hedge in part to the high cost of hedging EM currency through traditional currency swaps, forwards, and futures, especially in periods when interest rate differentials between developed and emerging economies increase. For example, between 2002 and 2017, the average implied cost to hedge an EM portfolio was 4.1%, whereas the average yearly performance of gold over that period was 11.2%. And while interest rate differentials have compressed, gold overlays remain highly cost effective, Perlaky states.
Meanwhile, the WGC on Wednesday reported that global gold-backed exchange traded funds (ETFs) holdings added 72.2 t of gold to a total of 2 481 t in April, reflecting the strongest month of net inflows in more than a year. Growth in global holdings was led by significant North American and European inflows and supported by a small increase in Asia.
ETF inflows were steady throughout the month despite the gold price retracing early gains, finishing April 1% down, after reaching an intra-day high of about $1 360/oz mid-month.
The WGC notes that global stocks were mostly higher during the month, but many indices remain down or flat for the year. Market uncertainty stemming from missile strikes in Syria by the US, the UK and France, as well as continued trade war rhetoric cast a cloud over the markets. At the same time, higher inflation expectations and a weaker US dollar through April offset the negative effect of higher interest rates on gold.
North American and European funds saw significant net inflows in April, growing by 3.4%, or $1.9-billion, and 2.8%, or $1.2-billion, respectively. Total fund holdings in Asia rose by 3%, or $100-million, to 80.2 t. Funds in other regions had a marginal loss of 1 t, or 3% of assets.