It’s worth its weight in Gold

Gold bullion prices have soared in the last year and since 2019 have doubled in value in US dollar terms and are up almost 2.5x in AUD.  This strong rise, coupled with recent share market volatility, has renewed investor interest in gold’s role within diversified investment portfolios.  We’ll explore the drivers behind the rally, the strategic functions and practical considerations for an Australian investor who may be contemplating gold allocations in 2025.

There have been multiple factors influencing the surge in gold in recent years, and structural factors in the long run.  

Recently rising geopolitical tensions, high and rising government debt, an episode of high inflation and renewed central bank buying for strategic reserves all contribute to reasons supporting the price rise. Some supply factors, including mining production, which has been flat for the last decade, have increased the differential between supply and demand. For centuries, gold has been used as a currency, being a store of value and medium of exchange, particularly with gold coinage.

Past performance of gold

The first premise for owning gold is for long-term returns - with gold seeing strong returns in the last couple of years, and also over longer periods of time. However, gold returns can be episodic, with periods of negative returns after strong rallies. There is some caution around periods of disruption or “mania”. The mid-1970s saw gold rally after the US removed the gold peg to the US dollar. The late 1970s to 1980 saw a 500% rise in gold, followed by a drop of more than 50% over the following two years. There was also a decade of negative returns in the 1990s, followed by a decade of strong returns in the 2000s. The 2010s saw a strong rally followed by a sharp drop of 40%. Hence, the rationale for returns needs to take into account these very divergent long-term patterns. It is harder to consider gold when it is not popular and in the headlines, however historically, these have been the best times to allocate (for the very patient investor!).

Risk management has been a reason to allocate to gold, with correlations to other asset classes low, gold holds up well in most periods of financial market stress and day-to-day volatility is generally lower than equity markets. In the recent era of challenges for global trade, economies and financial markets have seen disruption, which has driven some investors to the relative stability of gold.

Diversification benefits, including as a long-term inflation hedge, are additional reasons. The purchasing power of long-term assets, such as gold, has held up relatively well compared to paper money.  This can be observed in some cases with the relative purchasing power of the USD and AUD versus gold. Diversification to different economic environments is another reason. In Ray Dalio of Bridgewater’s ‘All Weather Portfolio’, the premise in allocating to gold was to diversify a long-term portfolio with assets that perform in all quadrants of the cycles of economic growth and inflation.

Investors could consider gold in their portfolios but would be wise to assess their individual situation carefully.  Investors need to consider an allocation to gold as a very long-term, strategic allocation rather than a short-term chase for returns. If a client is more reliant on income and doesn’t have as much flexibility or excess capital, then gold may be challenging as an allocation, given it has no income and will likely have holding costs.  Individuals should consider their overall income, capital needs, potentially changing life stage situations, and intergenerational objectives.

Implementation options for gold include direct and indirect ways of gaining exposure.  The most familiar are gold bullion in physical bars and coins, noting these will require secure storage and insurance. There are Exchange Traded Funds (ETFs) available on the Australian Stock Exchange that have exposure to physical gold in ETF products. These ETFs have a management fee, and some have exposure to allocated gold, unallocated gold, and may have gold futures.  The riskier side of gold is gold mining stocks. While these are inherently leveraged, with corporate borrowings, this can magnify good and bad management decisions; hence, assessing the quality of the company assets and management operation of the assets is essential.  

Factors in sizing an allocation will depend to what extent an individual wants to make use of the features of gold investment. Some diversification benefit and modest protection can be gained for an allocation up to 5% within a diversified portfolio. Larger allocations could be considered if a more robust crisis protection character is sought for high equity risk portfolios. Examples of very high allocations are in endowment style and ‘all weather’ portfolios such as that proposed by Bridgewater’s Ray Dalio, and in the Harry Browne ‘permanent portfolio ' popularised in his 1999 book “Fail Safe Investing”. These portfolios can have gold allocated to an extreme of 25%. For an individual investor, a much more modest allocation would be prudent depending on their situation.

When deciding to invest in gold as part of a portfolio construction, consider timing, dollar cost averaging and any indicators that could speed up or slow down progress toward the long-term target allocation. Considerations such as central bank policies towards monetary policy and reserve purchases, alongside inflation expectations and real yields, are important. Geopolitical and trade tensions have been a recent factor, while there are seasonal factors for personal gold purchases in certain cultures.  Trying to avoid buying at highs when there has been a period of strong returns is difficult, however, patience can be rewarded in the long term if gold becomes less popular and provides better buying opportunities.

In conclusion, the surge in gold over 2024 and into 2025 has been supported by strong underlying demand, constrained supply, and an episode of high inflation that might be followed by a higher average inflation than the last three decades. Another factor for Australian investors has been a weaker Australian dollar, providing higher returns recently in AUD.  In considering an allocation, individuals should consult their advisor and consider modest allocations in line with their income and capital needs of their overall diversified portfolio. The true benefit of gold is in the long-term, so patience is needed for reduced portfolio volatility, long-term capital preservation and inflation hedging benefits.

Gold can provide a supporting role in a resilient portfolio construction within a changing and uncertain world.

 

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.