18 November 2019

Gold, a Strategic Investment

Why hold physical gold in an investment portfolio?


Gold doesn't go bankrupt!

Physical gold retains an intrinsic value regardless of circumstances and has done so for more than six millennia because it is a “tangible” asset rather than a “paper” asset dependent on the promise of a third party and evidence of their debt.

Physical gold has a fundamental quality that makes it unique compared to other financial products: It presents no counterparty risk. An investor is not exposed to the potential default of a third party in taking possession of his gold. Such an investor maintains direct control over his asset at all times. In contrast, an investor who holds a bond incurs a risk of default on interest and outstanding principal if the borrower becomes insolvent. Owning shares in the capital of a company, whether listed on the stock exchange or not, involves the risk of losing one’s investment entirely if the company goes bankrupt.

Recent news highlighting the widespread sovereign debt crisis clearly demonstrates that even securities issued by states are not risk-free and present a counterparty risk.

Gold safeguards against inflation and recession!

The value of gold expressed in terms of real goods or services has remained remarkably stable for centuries. The Golden Constant, a study updated in 2009 by the World Gold Council, illustrates how gold has maintained its purchasing power for five centuries. Indeed, the study began with statistics in Pounds Sterling that date back to 1560. Through their central banks, states regularly issue currency (aka "Quantitative Easing"): the value of currencies depreciates mechanically in consequence, because the supply has become almost unlimited. Thus, even “cash” can be risky, as euros or dollars will “buy” ever fewer goods and services and, above all, less gold. Gold is also a “reservoir of value” in the event of a drop in growth and economic activity with aggravated unemployment (deflationary recession). In this crisis scenario, the prices of traditional economic assets (shares, stock market, real estate) depreciate and the number of bankruptcies increases. Investors then take refuge in less risky assets (known as a “flight to quality”) such as money market securities and... gold. One financial simulation demonstrated that during the Great Depression of the 1930s, when the Dow Jones index lost 90% of its value from 1929 to 1932, holding 15% in gold would have covered all the losses a portfolio suffered on the stock market. Physical gold is therefore a simple and effective protection against the two macroeconomic crisis scenarios—inflation and recession—that currently threaten the global economy.

Gold outperforms in crisis situations!

Like a high-level athlete who achieves his best performance on the day of the competition, gold performs outstandingly in crisis situations. Let's take the recent and significant example of the banking crisis from 2007 to 2009 (including an “acme” during the episode of the collapse of Lehman Brothers in September 2008): In 2 years, financial securities shed 65%, while the price of gold in dollars increased by 40%. During this stock market debacle, fund managers had to face massive “calls for collateral” due to their loss-making trading positions,  creating asymmetry. Assets considered “risk-free” (government bonds, money market funds) saw their liquidity dry up sharply. During the crisis, gold was one of the few assets that fund managers were able to sell easily to meet calls for collateral.

The strong performance of gold in times of crisis can of course be explained by the absence of credit risk linked to its holding, but also by its unique status as a “universal” asset, offering at all times a particularly liquid market on which very large volumes are traded and whose valuation is transparent and recognized worldwide. Moreover, and unlike conventional financial assets, the demand for gold does not depend solely on the investment sector. The WGC estimates that about 60% of gold demand comes from the jewelry sector, 13% from industrial and technological use, and the remaining 27% from investment demand. This diversity of demand for the gold as a commodity is a factor in stabilizing its value, even in times of financial crisis.


Gold is liquid!

The gold market is the most “liquid” market overall in terms of trading volume: On average, USD 100 billion of gold is traded daily on the financial markets of London, New York, and Tokyo. This volume is higher than the government bond markets in Germany or England, without taking into account transactions on other markets, such as Hong Kong, Shanghai, Taiwan, or Istanbul, which are constantly growing. Thus, investors anywhere are guaranteed that the market will be able to quickly process any buy or sell order, at any time. Conversely, this is not the case for real estate, the other major “tangible” asset, where each specific transaction takes a long time to complete.

Gold offers market depth!

The very important and often underestimated notion of “market depth” can be defined as the total value of assets held by all participants in a given market. The World Gold Council estimates that in 2010, approximately USD 2.4 trillion was held in the form of gold bullion and coins by institutions and individuals around the world. Once again, this depth figure is higher than that of government bond markets (e.g. English Gilts). The main virtue of this depth is that it allows transactions of all sizes to be carried out globally and absorbed by the market without disruption. Thus, a sale of several hundred tons of gold by the IMF in 2010 was carried out smoothly on the “over-the-counter” market.

Gold possesses a simple and clear valuation!

The price of the yellow metal is undoubtedly one of the listings most followed worldwide, not only by financial operators but also by many industrial and technological sectors and private individuals. The price is officially established in London by twice daily “fixing,” according to a ritual unchanged since 1919: The approved market makers compare world supply and demand from all operators wishing to participate in the fixing until they reach an equilibrium price, which is then published by the LBMA in US dollars, Euros, and Pounds Sterling. This universal gold quotation, based on a simple and transparent mechanism, makes the valuation of any direct holding in physical gold indisputable at any time and in any place.


Gold: the best form of diversification!

Gold is nobody's debt. It therefore cannot be adversely affected in the context of widespread payment defaults; it is not correlated with what are known as risk assets. Statistical studies by the World Gold Council show that changes in the price of gold are decorrelated from those of the riskiest assets and correlated only weakly with traditional assets such as major stock exchanges, bonds, and real estate. This low correlation with other financial assets makes gold a strong candidate for diversifying a portfolio. Thus, gold is not only a safeguard for value but also contributes to optimizing the performance of a traditional investment portfolio, combining financial performance, and risk reduction. This diversification capacity is valid both over the short term (tactical optimization) and the long term (strategic optimization).

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