Gold as an investment?
The original hedge against uncertainty
In turbulent times, preserving your capital can be an even more important concern than growing your capital. With this in mind, investors regularly include gold in their portfolios and consider it a ‘safe haven’ asset because when equity and bond values fall during periods of volatility, the price of gold tends to rise. Gold is also seen as a ‘store of value’ asset which can hold its worth over the long term.
Why invest in gold?
During exceptional circumstances, such as geopolitical upheavals or financial downturns, gold has a reputation for outperforming most other asset classes. In the aftermath of the 2008 financial crisis, for example, as stock markets plummeted, the price of gold rose steeply to its highest level in 30 years.
Gold is also held by investors as a protection against long-term inflation. Consider how dramatically house prices have risen over the decades, in fact the average UK house price has increased by 273% since 1959 in real terms (Halifax, January 2010). However, in gold terms, the average price of buying a house in the UK since the 1960s has remained steadily between 200-250oz of gold.
"Significant increases in inflation will ultimately increase the price of gold. Investment in gold now is insurance."
The unusual commodity
Unlike most commodities such as wheat or copper, which have their price determined by physical supply and demand, the price of gold tends to be driven by other factors including exchange rates and bond yields.
Some of these gold price drivers include:
The US Dollar
The price of gold and the US Dollar tend to move in opposite directions. Reasons for this can include:
- A falling US Dollar increases the value of other foreign currencies and boosts commodity prices, so the gold price also rises.
- As the value of the US Dollar falls, investors look for other stores of value and often turn to gold. Rising demand for gold leads to an uplift in price.
High inflation
If inflation is trending upwards, the real value of money is being eroded so investors often turn to ‘hard assets’ like gold which are considered to have intrinsic value.
Unlike other commodities, gold is not closely tied to the economic cycle, as demand comes from sectors such as jewellery, industry and technology (cyclical sectors) as well as investment and government (non-cyclical sectors).
Low interest rates
In an environment of low interest rates, the gold price often rises. This may be because low interest rates tend to go hand in hand with an expansion of the money supply which can stoke inflation. As noted above, gold is seen as a protection against inflation.
Political risk
It can be difficult for investors to protect their portfolios against unexpected global events such as wars, political crises or shock election results. However, events like these often cause a strong demand for gold, sending the price upwards. So, holding gold can act as portfolio protection against such events.
This chart demonstrates the connection between investor anxiety over political or financial events and the price of gold.
How can gold benefit a portfolio?
Most portfolios are heavily invested in equities, which means there is limited asset diversification. If stock markets fall, most of the equities held will fall too. By contrast, a portfolio well diversified through different types of assets should produce a range of reactions to a stock market fall, potentially avoiding a wholesale drop in value.
The shocks that send equity prices lower can often trigger a rise in the gold price, as market participants hurry to buy into the perceived ‘safe haven’ of gold. For this reason, gold can be seen as a ‘defensive’ asset, which can offer portfolio protection.
In the past 10 years, during the FTSE 100’s worst 10 months of performance, where it has fallen by 8.2% on average, gold prices have risen, on average, by 3.8% in local currency terms (Source: Bloomberg, ETF Securities, February 2017).
Historical performance is not an indication of future performance and any investments may go down in value.
How can you hold gold?
There are a number of ways to add gold to a portfolio. Gold can be held physically, via exchange traded products (many of which are physically backed by gold), by using sophisticated derivatives such as gold futures, or by holding gold mining equities, which are affected by gold prices. Here’s a look at these options in greater detail.
How to invest in gold
Physical gold bullion
Physical gold bullion bars or coins can be purchased from a dealer.
Advantages: Perfect correlation to the gold price. No third-party risk.
Disadvantages: The costs of storing and insuring physical gold can be significant. Buying and selling physical gold can be complicated and expensive.
Exchange traded products (ETPs)
Gold ETPs are financial instruments which passively track the gold price, or take short and/or leveraged positions. ETPs are bought and sold like shares and can be backed with physical gold (see below).
Advantages: ETPs provide exposure to gold without having to hold physical gold, making this a cost-effective route. Historically there is a good correlation to the gold price. ETP shares are easily bought and sold.
Disadvantages: There are usually management and trading fees for this kind of investment. There is third-party risk.
Gold mining equities
Holding gold mining stocks will give an investor exposure to the gold price, as the value of these stocks is driven in part by gold prices.
Advantages: These stocks are publicly listed and usually straightforward for investors to buy and sell. They also can provide investors with dividend earnings.
Disadvantages: They may not reflect the gold price perfectly and can be subject to volatility.
What is a physically backed ETP?
ETPs are financial instruments that can be traded on a stock exchange like shares. They are designed to passively track an underlying asset or index.
A physically backed ETP holds the commodity it is tracking. This is only possible if the commodity can be stored for long periods, so physically backed ETPs are usually only for precious and industrial metals. So, in the case of a physically backed gold ETP, physical gold is held in a secure vault by the ETP provider and inspected regularly by an independent body.
A number of organisations oversee and standardise the trade of precious and industrial metals including, the London Bullion Market Association (LBMA) and the London Metal Exchange (LME). They ensure metal quality and inspect storage.
Precious metals are stored in vaults located in London, Zurich or Singapore. Industrial metals are usually stored in warehouses inspected by the London Metal Exchange.
The value of a physically backed commodity ETPs comprises:
The advantage of physically backed ETPs is that they provide exposure to the chosen commodity’s price movements, while investors can be reassured by the knowledge that each ETP is backed by an entitlement to high-quality, securely stored physical metal.
Visit our education hub to find out more about ETP structures.
Can investing in gold be tax efficient?
For UK investors, holding gold investments within an ISA or pension plan could provide tax-efficient benefits.
Within these plans, if an investment gains in value, the gain is not currently subject to income or capital gains taxes.
For UK investors, holding gold investments within a tax wrapper, such as an individual saving account (ISA) or pension plan could provide tax-efficient benefits. If the investment gains in value, the advantage of holding gold ETPs in a tax wrapper is that the gains are not currently subject to income or capital gains taxes.
Holding physical gold bullion in a pension plan can incur additional costs, such as storage and maintenance costs by bullion dealers. This is not the case with physical gold ETPs, which incur costs similar to buying and selling shares: management fee & broker/platform charges. Physical gold ETPs provide efficient exposure to physical gold, without having to hold physical gold, and are easier to hold in a diversified portfolio.
ETF Securities (UK) Ltd is not a tax adviser. Please seek independent professional advice as tax Laws and rules are subject to change and can vary with individual circumstances.
Visit our ISA hub for more information
The intelligent alternative
ETF Securities is dedicated to making specialist multi-asset investment opportunities accessible. We enable investors to build and diversify their portfolios intelligently.
Our aim is to deliver the best investment solutions possible, by replacing complexity with clarity, from product design and build through to sales, marketing and education.
We are pioneers, having developed the world’s first gold ETP. Today we offer one of the most innovative ranges of specialist ETPs covering commodities, FX, equities and fixed income.
Using our pioneering spirit, unrivalled expertise, and by working with leading third parties, we seek out the most compelling investment opportunities and make them accessible to investors as the intelligent alternative.
For more information on gold and our offerings, visit
etfsecurities.com/gold
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