The Strategic Case for Gold….Responsible Gold!

Gold as a Strategic Asset Class

Gold has played an important strategic role in a well-diversified portfolio as a long-term investment. Typically viewed as a safe-haven asset during periods of economic uncertainty, gold’s scarcity has also preserved its value over time. Its sources of demand are diverse too—as an investment, a reserve asset, in art and jewelry as well as in technology components. 

As a result, gold can enhance a portfolio in three important ways:

• Delivering long-term returns 
• Improving diversification 
• Providing liquidity

Given the diversity in demand, the precious metal has delivered solid returns in various market conditions. During periods of economic uncertainty, the counter-cyclical investment demand drives gold prices up. During periods of economic expansion, pro-cyclical consumer demand supports its performance. Combining these two factors enables gold to provide stability under a range of economic environments.

Another feature of gold is its low correlation to traditional asset classes, (Chart 1) which decreases even further during times of market sell-off (Chart 2). Many assets become increasingly correlated as market uncertainty rises and volatility is more pronounced. As a result, many presumed diversified assets may not protect portfolios when investors need them most. Gold has consistently performed well during market volatility.

Chart 1
A Good Diversifier in Uncertain Markets
The Low Correlation of Gold (1/1/1990 – 4/30/2023)

The gold market is significant and highly liquid. It is estimated that investor and central bank holdings of physical gold are worth approximately US$4.8 trillion, with an additional US$1 trillion in the over-the-counter (OTC) market. The best current estimates suggest that approximately 208,874 tonnes of gold have been mined throughout history.

Before the introduction of exchange-traded fund, investors looking to add gold exposure generally chose between holding physical gold, investing in derivatives or gold producers. 

Investing in the equities of mining companies, however, can provide less precise exposure to gold given that mining companies may hedge exposures to the price of gold.  

Since the advent of gold exchange-traded funds, investors have pure access to gold bullion exposure in low cost, tradable and efficient manner.   Physically backed gold ETFs offer an added source of liquidity, with global gold ETFs trading an average of US$2.3 billion per day.¹

Improved Risk Adjusted Returns

By adding gold to a traditional 60/40 portfolio, risk-adjusted returns can be improved as measured by a portfolio’s Sharpe ratio. This shows the power of diversification and the low correlation of gold to traditional equity and fixed income markets (Chart 3).

Chart 3
Gold Has Improved Risk-Adjusted Returns
Sharpe Ratio Comparison of Portfolios with Different Gold Weightings

Responsibly Sourced Gold

The London Bullion Market Association (LBMA), an international trade association representing the global over-the-counter bullion market, established a set of standards known as “Good Delivery” in response to growing customer demand for the responsible sourcing of gold. Considered a leading authority on precious metals, LBMA developed a “Responsible Sourcing” due diligence framework in 2012. The goal was to assure accredited refiners commit to implementing a set of international standards intended to ensure gold is mined through verified supply chains. Approved LMBA refiners are required to demonstrate their efforts to respect the environment, including the management of harmful chemicals and pollutant and combat money laundering, terrorist financing and human rights abuses.

The first step in the framework calls for establishing strong company management systems via clearly stated policies, partner agreements and training. The second step calls for risk assessment for upstream and downstream companies in addition to traceability documentation that meets a variety of criteria. The third and fourth due diligence steps involve audits and plans to respond to risks. Finally, the program’s fifth step mandates public reporting of a company’s in-depth due diligence and monitoring processes. (Chart 4)

We believe gold’s scarcity, liquidity, and low correlation with other assets class makes Gold ETFs a compelling diversifier for a variety of market environments. We believe this dynamic will likely continue with the ongoing uncertainty surrounding the equity and bond markets. And while gold mining is an extractive industry, investors can isolate responsible gold miners that follow a rigorous framework to mitigate environmental and social impact. 

For more information on a solution to invest in responsibly sourced gold, please contact:

Bobby Eng, CIMA® 
Senior Vice President
Head of Institutional ETF Distribution
Franklin Templeton Canada
Tel: 647-524-3238
[email protected]

Notes:

1. goldhub.org

Bobby Eng’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions