The Value of Gold as an Asset Class

Since 2007, it has been increasingly clear that gold IS a separate asset class, apart from equities, even apart from other commodities. If you check the performance of other precious metals like Platinum, Palladium and Silver, their prices move almost in lock step with stocks. But not gold. In 2008, as stock markets plunged over 50%, gold fell only around 200USD/oz or 25% to around USD690/oz. This year, gold shot up by another 10% whereas stock markets are lower now than at the start of the year.

Published June 25, 2010

The value of gold as an asset class


THE resurgence of gold sends mixed signals to investors. Traditionally, gold is seen as a store of value and hedge against inflation, a safe haven in turbulent times. Increasingly, it is seen as a currency in itself, the ultimate hedge against the collapse of paper currency. The paradox is that the escalation of the gold price suggests a collapse of the financial system as we know it - surely a dire outcome. To date, the trajectory of gold has been impressive. Since 2000, gold has delivered annualised returns of over 16 per cent in US dollar terms, resoundingly beating the S&P 500's minus 0.91 per cent return and the STI's 5.16 per cent. It is, of course, not coincidental that its ascendance has occurred in a decade awash in extreme volatility, crisis and unprecedented action by central banks. Stock and bond prices have swung wildly between expectations of deflation and inflation; and major currencies - the US dollar and now the euro - have weathered substantial declines.


Through all this, gold has been a relative haven, and that must have lent weight to its status as an alternative asset worth consideration - when it was dismissed by most advisers just a decade ago. But the questions of valuation, timing and price of entry must surely puzzle investors, particularly those who recall gold's long fallow period in the 1980s and 1990s. At the current price of US$1,236 per ounce, does it present good value? Perhaps one of the more persuasive arguments would be the inflation-adjusted price of gold. As UBS points out in a recent report, the price of gold at about US$1,200 would have to rise 90 per cent to reach its 1980 peak of US$850 in real, inflation-adjusted terms. In contrast, the US dollar has lost some 30 per cent of its purchasing power over the last 30 years.

For now, uncertainty about the sustainability of an economic recovery is providing a tailwind for gold that is set to continue over the next few months, particularly as Europe muddles through its debt crisis and the euro suffers the fallout. For investors, the opportunity cost is supportive as interest rates are expected to remain low. Sentiment is likewise conducive as investors, with the crisis of 2008 still fresh in their minds, welcome an asset that does not quite behave in lock-step with stocks and bonds. To be sure, the entry of institutions and pension funds is yet another anchor in terms of price. In April, gold-backed exchange-traded products shot up, and Barclays notes that interest has proved more 'sticky' and longer term in nature.

For investors, the key is moderation and a portfolio context. While gold has indeed been rewarding, it has been volatile in the last 18 months, dipping below US$700 in mid-2008. While it is liquid, gold has no income or coupon to cushion price falls. Strategists reckon a prudent allocation at between 10 and 15 per cent. That is higher than the standard advice five years ago to invest no more than 5 per cent. Gold in this context is a form of insurance against a doomsday scenario that one hopes will never arrive.