Gold does not directly conform to the majority of the most common valuation methodologies used for equities or bonds. Without a coupon or dividend, typical models based on discounted cash flows, expected earnings, or book-to-value ratios, struggle to provide an appropriate assessment for gold’s underlying value. This presented an opportunity for the World Gold Council to develop a framework to better understand gold valuation.
Returns
Diversification
Liquidity
Portfolio performance
2020 posed unprecedented challenges to investors as the first global pandemic in a century ravaged the world economically and socially.
COVID-19 significantly increased uncertainty by compounding existing risks and creating new ones. The rollout of new vaccines at the end of last year fuelled optimism that the worst was over. Yet the pandemic and the ensuing policy response from governments will likely have unintended consequences for, and create structural changes to, asset allocation strategies.
Global central banks have effectively taken interest rates to zero, driving nearly all sovereign debt to negative real yields. With less opportunity for yield across fixed income assets – especially those of shorter duration or higher quality – investors will likely continue to shift exposure to riskier assets. This has pushed many global stock markets to extreme levels on numerous valuation metrics and – importantly - has also served to increase the risk profile of most investment portfolios.
Additionally, many countries have made it clear they will continue to enact sizeable fiscal policy measures to tackle the economic impact of COVID-19, along with expanding budget deficits and balance sheets.
We believe these actions - in combination with the current environment have made gold increasingly relevant as a strategic asset. Not only could investors benefit from gold’s role as a diversifier amid ballooning budget deficits, inflationary pressures, and potential market corrections from already high equity valuations, but they may also see additional support as gold consumption will likely benefit from the nascent economic recovery, especially in emerging markets (see 2021 Gold Outlook).
Over recent years, investors have increasingly looked to integrate environmental, social and governance (ESG) considerations as part of their investment process. For example, 89% of European investors now take ESG factors into account when they make investment decisions.2 This increased emphasis on ESG reflects increasing pressure for businesses to actively manage ESG risks. It also emphasises that good ESG performance could lead to better long-term financial performance.3 This shift towards a greater integration has important implications for gold, which needs to demonstrate that it is produced and sourced responsibly, as well as the role that gold can play in supporting ESG objectives within a portfolio (Focus 2: Gold is an ESG investment).4
Institutional investors5 have embraced alternatives to traditional investments such as equities and bonds in pursuit of diversification and higher risk-adjusted returns. The share of non-traditional assets, such as hedge funds, private equity funds or commodities, among global pension funds increased from 7% in 1999 to 26% in 2020 (Chart 1).6
Gold allocations have been recipients of this shift. Investors increasingly recognise gold as a mainstream investment; global investment demand has grown by an average of 15% per year since 2001 and the gold price has increased five-fold over the same period.7
Our analysis illustrates that adding between 2% and 8% in gold to a hypothetical Chinese insurance fund average portfolio over the past decade would have resulted in higher risk-adjusted returns.8
Our analysis shows gold is a clear complement to equities, bonds and broad-based portfolios. A store of wealth and a hedge against systemic risk, currency depreciation and inflation, gold has historically improved portfolios’ risk-adjusted returns, delivered positive returns, and provided liquidity to meet liabilities in times of market stress.
Investors have long considered gold a beneficial asset during periods of uncertainty. Historically, it has generated long-term positive returns in both good and bad economic times. Looking back almost half a century, the price of gold in US dollars has increased by an average of nearly 11% per year since 19719 when the gold standard collapsed.10 Over this period, gold’s long-term return is comparable to equities and higher than bonds.11 Gold has also outperformed many other major asset classes over the past five, 10 and 15 years (Chart 2 and Chart 3).
This duality reflects the diverse sources of demand for gold and differentiates it from other investment assets. Gold is often used to protect and enhance wealth over the long term as it is no one’s liability, and it operates as a means of exchange due to its global recognition.
Gold is also in demand via the jewellery market, valued by consumers across the world. And it is a key component in electronics.12 These diverse sources of demand give gold a particular resilience: the potential to deliver solid returns in various market conditions (Chart 7, p6).
Gold has long been considered a hedge against inflation and the data confirms this. The average annual return of 9% in RMB over the past 15 years, has outpaced the Chinese consumer price indices (CPI).13
Gold also protects investors against high and extreme inflation. In years when inflation was higher than 3%, the RMB gold price increased 11% per year on average (Chart 4). Over the long term, therefore, gold has not just preserved capital but helped it grow.
Research also shows that gold should do well in periods of deflation.14 Such periods are characterised by low interest rates, reduced consumption and investment, and financial stress, all of which tend to foster gold demand.
Investor demand has been boosted by persistently low interest rates and concerns about the outlook for the dollar, which affect the perceived opportunity cost of holding gold.
Historically, major currencies were pegged to gold. That changed with the unravelling of the US gold standard in 1971 and the eventual collapse of the Bretton Woods system.15 Since then, with few exceptions, gold has significantly outperformed all major currencies and commodities as a means of exchange (Chart 5). This outperformance was particularly marked immediately after the end of the gold standard. A key factor behind this robust performance is that the supply growth of gold has changed little over time – increasing by approximately 1.4% per year over the past 20 years.16
By contrast, fiat money can be printed in unlimited quantities to support monetary policy, as exemplified by the quantitative easing measures in the aftermath of the Global Financial Crisis (GFC).17 In recent years, the rapidly increasing global money supply and a low to negative rate environment have fostered an optimal environment for gold to outperform global sovereign debt, such as US treasuries and to track the global money supply (Chart 6, p6).
The benefits of diversification are widely acknowledged – but it is hard to find effective diversifiers. Many assets become increasingly correlated as market uncertainty rises and volatility is more pronounced, driven in part by risk-on/risk-off investment decisions. As a result, many so-called diversifiers fail to protect portfolios when investors need them most.
Gold is different in that its negative correlation to equities and other risk assets generally increases as these assets sell off (Chart 7). The Global Financial Crisis is a case in point. Stocks and other risk assets tumbled in value, as did hedge funds, real estate and most commodities, which were long deemed portfolio diversifiers. RMB gold, by contrast, held its own and increased in price, rising 64% from December 2008 to December 2009.18 And in the most recent sharp equity market pullbacks of 2015 and 2020, gold performance remained positive.19
This robust performance is perhaps not surprising. With few exceptions, gold has been particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses (Chart 8, p7). Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, or possibly mispriced.
But gold’s correlation does not just work for investors during periods of turmoil. It can also deliver positive correlation with equities and other risk assets in positive markets, making gold a well-rounded efficient hedge (Chart 9, p7), (see Gold: an efficient hedge).
This dual benefit arises from gold’s dual nature: as both an investment and a consumer good (Chart 18, p15). As such, the long-term performance of gold is supported by income growth. Our analysis bears this out, showing that when equities rally strongly, their correlation to gold can increase. This is most likely driven by a wealth-effect supporting gold consumer demand, as well as demand from investors seeking protection against higher inflation expectations.
Gold has consistently benefited from “flight-to-quality” inflows during periods of heightened risk.
Gold behaves – and is used – as a safe-haven in periods of systemic risk…
…but also performs well in market recoveries.
The gold market is large, global and highly liquid.
We estimate that physical gold holdings by investors and central banks are worth approximately RMB 31tn, with an additional RMB 7.6tn in open interest through derivatives traded on exchanges or the over-the-counter (OTC) market (Chart 16a, p14).
The gold market is also more liquid than several major financial markets, including the CSI 300, euro/yen and Shanghai Stock Composite Index, while trading volumes are similar to those of the S&P 500 (Chart 10). Gold’s trading volumes averaged approximately RMB 1.2tn per day in 2020. During that period, OTC spot and derivatives contracts accounted for RMB 720bn and gold futures traded RMB 451bn per day across various global exchanges. Gold-backed ETFs (gold ETFs) offer an additional source of liquidity, trading an average of RMB 22bn per day (Chart 11) with the largest China-listed funds trading an average of RMB 1.7bn per day in 2020.
The scale and depth of the market mean that it can comfortably accommodate large, buy-and-hold institutional investors. In stark contrast to many financial markets, gold’s liquidity does not dry up, even at times of financial stress, making it a much less volatile asset (Chart 12).
Long-term returns, liquidity and effective diversification all benefit overall portfolio performance. In combination, they suggest that the addition of gold can materially enhance a portfolio’s risk-adjusted returns.
Our analysis of investment performance over the past one, five, 10 and 15 years underlines gold’s positive impact on an institutional portfolio. It shows that the Singapore average portfolio would have achieved higher risk-adjusted returns and lower drawdowns if 3%, 6%, or 8% were allocated to gold (Chart 13 and Table 1). This positive impact has been particularly marked since the GFC.
Looking to the future, stronger dynamics apply. Our analysis estimates that Chinese-based investors could have benefitted from a material enhancement in risk-adjusted returns if they had allocated between 2% and 8% of a well-diversified portfolio to gold (Chart 14, p10).20
The amount of gold varies according to individual asset allocation decisions. Broadly speaking however, the higher the risk in the portfolio – whether in terms of volatility, illiquidity or concentration of assets – the larger the required allocation to gold, within the range in consideration, to offset that risk (Chart 14, p10).
Our analysis also indicates that gold’s optimal weight in these hypothetical portfolios can be statistically significant even if investors assume an annual return for gold of between 2% and 4% – well below long-term historical performance. This works equally for investors who already hold other inflation-hedging assets, such as inflation-linked bonds,21 and for investors who hold alternative assets, such as real estate, private equity and hedge funds.22
Comparison of a hypothetical Chinese insurance fund average portfolio and an equivalent portfolio with 5% gold over the past one, five, 10 and 15 years based on RMB returns*
| 20-year | 10-year | 5-year | 1-year | |||||
|---|---|---|---|---|---|---|---|---|
| No gold | 5% gold | No gold | 5% gold | No gold | 5% gold | No gold | 5% gold | |
| Annualised return | 4.8% | 5.0% | 3.6% | 3.6% | 2.1% | 2.7% | 5.2% | 5.8% |
| Annualised volatility | 9.0% | 8.7% | 6.7% | 6.5% | 5.3% | 5.1% | 5.4% | 5.4% |
| Risk-adjusted returns | 0.54 | 0.58 | 0.54 | 0.55 | 0.40 | 0.53 | 0.97 | 1.10 |
| Maximum drawdown | -37.3% | -36.3% | -18.7% | -18.0% | -8.7% | -8.0% | -3.5% | -3.8% |
*As of 31 December 2020. Each hypothetical portfolio composition reflects a percentage in stocks, cash equivalent assets, bonds and gold as described in Chart 13. And asset weights’ adjustments are subjected by China Banking and Insurance Regulatory Commission’s investment restrictions on insurance funds.
Source: Bloomberg, Shanghai Gold Exchange, ChinaBond Pricing Center, China Securities Index, ICE Benchmark Administration, World Gold Council Source: Bloomberg, ICE Benchmark Administration, World Gold Council
Perceptions of gold have changed substantially over the past two decades, reflecting increased wealth in the East and a growing worldwide appreciation of gold’s role within an institutional investment portfolio.
Gold’s unique attributes as a scarce, highly liquid, and un-correlated asset demonstrate that it can act as a diversifier over the long term. Gold’s position as an investment and a luxury good has allowed it to deliver average returns of nearly 11% over the past 50 years, comparable to equities and more than bonds and commodities.26, 27
Gold’s traditional role as a safe-haven asset means it comes into its own during times of high risk. But gold’s dual appeal as an investment and a consumer good means it can generate positive returns in good times too. This dynamic is likely to continue, reflecting ongoing political and economic uncertainty, persistently low interest rates and economic concerns surrounding equity and bond markets.
Overall, extensive analysis suggests that adding between 2% to 8% of gold to a RMB-based portfolio can make a tangible improvement to performance and boost risk-adjusted returns on a sustainable, long-term basis.29
China’s economy has had a swifter recovery relative to other regions with the spread of the COVID-19 pandemic reducing greatly since Q1 2020, ending the year with a 2.3% y-o-y rise.30 But uncertainties in different aspects of the country’s economy could remain as we entered the new decade. As a result, challenges might also arise for Chinese investors’ portfolio construction going forward
Driven by sufficient containment of the COVID-19 pandemic, the economic recovery and accommodative monetary/fiscal polies, China’s stock market has rallied after Q1. The CSI300 stock index, a proxy of the Chinese stock market, surged by 27% in 2020.31
But in the meantime, price-earnings ratios (P/E) of top-performing sectors and the CSI300 stock index itself have risen to above or near their 90 percentile levels.32 And as the market’s valuation kept climbing despite possible uncertainties in the global and local economic development as well as the persisting COVID-19 pandemic, historical evidence shows higher volatilities in the stock market are often associated with lofty valuation levels.33
The possibility of China’s inflation picking up could rise in the future. As the spread of the pandemic significantly reduced, many industries resumed normal operation after Q1 2020, leading to higher productivity and easing China’s inflationary pressure as a result. And inflation could become a concern for Chinese investors:
Supported by a strong trade balance and faster economic revival relative to other markets,36 China’s RMB appreciated by over 6% against the US dollar in 2020.37 But potential uncertainties may weaken its supports in the future. First, China’s trade balance could decline, weakening the currency’s driving force. Major economies have made progress in rolling out vaccines against coronavirus which could limit the pandemic’s impact on their productivity.38 This might lead to lower exports for China. Also, with China’s economy reviving, its imports could rise further.
Second, interest rate spreads between China and major markets could narrow. Strong economic recoveries and prudent monetary and fiscal policies have led to higher interest rates in China than other markets, supporting the RMB’s appreciation in 2020.39, 40 With the possibly of other region’s economic revivals rising, the difference between market interest rates in these regions and China could reduce, further impairing the RMB’s supporting factor.41
Combined with aforementioned factors, our analysis shows including RMB gold into investors’ portfolios could:
Being one of the best RMB asset performer in 2020, gold has also offered Chinese investors attractive returns in the longer term.42
The first Chinese gold ETF was listed in 2013, ten years after demand for gold ETFs took off in the Western market.43 And at the end of 2020, gold holdings of the eleven gold ETFs listed at Chinese stock exchanges totalled 61t, a 38% increase in the year. Meanwhile, their assets under management (AUM) reached RMB 23.8bn as of 2020, hovering around the highest level on record.
In the first half of 2020, three gold ETFs were listed, all of which are at least 90% backed by the Shanghai Gold Exchange (SGE)’s Au9999 physical gold contract just like the original ones. Soon after, four Shanghai Gold ETFs were launched in Q3. As their names suggest, they are similarly backed by Shanghai Gold Benchmark contracts – another major physical gold contract at the SGE.44
In addition, investors can trade gold ETFs via various popular online channels, including WeChat and Ali-pay – two of the most frequently used apps in China, enabling fast and easy access to gold for retail investors.45
The liquidity of Chinese gold ETF market were also improving. The average daily trading volumes of the four largest gold ETFs in 2020 soared by over 90% compared to 2019.46 And the largest gold ETF’s average daily turnovers in 2020 exceeded RMB 1.5bn, higher than many Chinese stock index ETFs.47 Such a deep and liquid market allows retail and institutional investors to access gold at minimal fraction costs and exit the market smoothly.
1Oxford Economics is a leader in global forecasting and quantitative analysis and a specialist in modelling. Visit QaurumSM for important disclosures about Oxford Economics’ data, as well as a detailed description of the available scenarios; the assumptions underlying and data used for each scenario; and its respective hypothetical impact on gold demand, supply and performance.
2Mercer European Asset Allocation Insights 2020, August 2020
3Refinitiv, How do ESG scores relate to financial returns, August 2020.
4Gold and climate change: Current and future impacts, October 2019
5An institutional investor holds and/or manages assets for clients in larger, pooled portfolios often represented as mutual funds, banks, brokerages, hedge funds, etc.
6Willis Towers Watson, Global Pension Assets Study 2021 and Global Alternatives Survey 2017, July 2017.
7Returns in Chinese RMB from 31 December 2000 to 31 December 2020.
8See Chart 13 on p9 for more details behind the composition of the hypothetical Chinese insurance fund portfolio. Based on 2000 – 2020. In addition, refer to important disclaimers and disclosures at the end of this report.
9January 1971 – December 2020.
10During the gold standard, the US dollar was backed by gold, and the foreign currency exchange rates were dictated by the Bretton Woods System. In August 1971, the Nixon Administration announced the halt of the free conversion between the US dollar and gold catalysing the collapse of the gold standard and, subsequently, the Bretton Woods system.
11For other return metrics and performance see Appendix II on page 17.
13Based on average annual CPI changes for China as measured by the National Bureau of Statistics from December 2000 – December 2020.
14Oxford Economics, The impact of inflation and deflation on the case for gold, July 2011.
15Ibid footnote 10.
16From December 2001 – December 2020. See the Demand and Supply section at Goldhub.com.
17For more information please see The impact of monetary policy on gold and It may be time to replace bonds with gold.
18Based on Au9999 from 1 December 2008 to 30 November 2009.
19Based on the Au9999 in RMB from 12 June 2015 to 30 September 2015 and 31 January 2020 to 31 March 2020.
20Analysis based on the re-sampled efficiency methodology developed by Richard and Robert Michaud and praised as a robust alternative to traditional mean-variance optimisation. See Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, Oxford University Press, January 2008.
21Gold as a tactical inflation hedge and long-term strategic asset, July 2009, July 2009.
22Enhancing the performance of alternatives with gold, February 2018.
23See: Gold: the most effective commodity investment, and Gold: metal by design, currency by nature, Gold Investor, Volume 6, June 2014.
24For more information on the gold weight increases see: Major commodity indices will increase gold weightings for a second year in a row.
25Gold: the most effective commodity investment, September 2019.
26Average annualised returns in US dollars from January 1971to December 2020.
28The Greenhouse Gas Protocol, Ecoinvent database. Please see Gold and climate change: Current and future impacts and Gold and climate change: An introduction.
30 For more information, please visit please visit here.
31 Calculation based on the CSI300 Index between 31 December 2019 and 31 December 2020. For more information about the index, please visit here.
32 Sector performances calculated between 31 December 2019 and 31 December 2020. For more information about different sectors, please visit herre
33 Based on daily data of the price-earnings ratio for the CSI300 Index and its 30 day rolling volatility between 31 December 2002 and 31 December 2020.
34 For more information, please visit here.
35 For more information about China’s policy stance, please visit here.
36 Trade balance refers to a country’s exports’ value net of its imports value. China’s trade balance calculation based on dates between 31 December 2019 and 31 December 2020.
37 Calculation based on USD/CNY between 31 December 2019 and 31 December 2020, for more information about the foreign exchange rate.
38 For information about COVID-19 vaccines and their progress, please visit here.
39 China’s interest rates refer to its 10-year Treasury yields
40 Calculation based on USD/CNY between 31 December 2019 and 31 December 2020, for more information about the foreign exchange rate please visit here.
41 For more information about the global economic recovery, please visit here.
42 Comparisons made among the CSI300 index, ChinaBond New Composite Index from ChinaBond valuation center, the CSI Chinese Commodities’ Index and the Shanghai Gold Exchange’s Au9999 in RMB between 31 December 2019 and 31 December 2020.
43 For more information about the ETF market in China and globally, please visit here.
44 For more information about the newly listed gold ETFs in China please visit here.
45As of 2019, Ali-pay’s annual active users reached 900 million in China. As of 2019, Licaitong, WeChat’s wealth management platform, accumulated over 150 million users and WeChat itself has more than 1 billion monthly active users.
46 Calculations based on the daily trading volumes of Huaan Gold ETF, Bosera Gold ETF, Guotai Gold ETF and E-fund Gold ETF between 31 December 2019 and 31 December 2020.
47 Calculations based on Huaan Gold ETF’s daily trading volumes between 1 January 2020 and 31 December 2020.
