Ever since Australia’s first major gold boom in the 1850s, the precious metal has always excited investors. The excitement is rewarding, often, and sometimes calamitous. But in those early days it revamped the colonies, boosted the economy and gave the nation a whole new identity as speculators ramped up their efforts to shovel the hills of Ballarat or Bathurst.
It’s ironic to think that gold these days is sought more as a defensive asset, designed to do well when the world is looking like a dangerous place to invest. For sure there’s the odd speculator who’s still happy, from time to time, to invest in the junior gold miner promising to deliver the goods, but for sophisticated investors gold is becoming a vital component of a balanced portfolio.
One reason why is that gold does better when other asset classes, such as shares, don’t do so well. Professional fund managers might say it’s de-correlated, or negatively correlated, from other asset classes, but that just means the price of gold has no relationship with what’s happening in the equity or bond markets. That’s good news because when the prices of shares and bonds are falling, the price of gold should be rising.
These characteristics make gold an asset that any investor should look to include in their portfolio.
Many Australian investors who have considered buying gold have instead bought gold miners’ stocks. The reality is that there is often very little relationship between gold and gold miners’ stocks because gold mines are exposed to all the vagaries of trying to keep a mining company profitable, for example, exploration and extraction. Gold itself has a simpler supply and demand chain that dictates its price.
It appears investors in other countries are savvier about the benefits of gold in their portfolios. More and more SMSF-equivalent portfolios (401K in the United States and self-invested personal pensions in the United Kingdom) hold 1 per cent to 5 per cent in gold depending on whether they see the market as being in growth or in decline. That doesn’t sound like much, but it’s enough to give more than a marginal benefit in most markets and a material benefit in strongly negative ones. In recent weeks, billions of dollars have been allocated to exchange-traded funds (ETF) in the US and Europe as many investors respond to a market exhibiting less stability than in the previous few years.
So how do you buy gold if you don’t have a vault to secure it in or the ability to assess its purity? The Australian Securities Exchange has several ETFs that track the price of 99.5 per cent purity gold bullion (the internationally accepted benchmark). You pay a small spread to buy through your platform and an annual management fee (management expense ratio), which is typically 0.4 per cent or less. In the safest form of gold ETF, the gold is directly allocated to your units. This means you effectively own part (or all) of an actual gold bar stored and secured on your behalf.
Buying Australian shares seems like the right thing to do for many investors. It certainly feels like the natural investment choice as it’s familiar, however, adding a little bit of gold can go a long way to keeping your hard-earned capital protected.
Usually, Australian investors are good at having a fair chunk of their portfolio in shares, which does make sense. These companies, like the major banks and miners, are often well known, have no currency risk and come with the advantage of franking credits. But in reality there is substantial risk embedded in these portfolios. Why?
Conventional financial theory (and, actually, in practice) states that if you hold fewer than 30 different companies, you won’t benefit from diversification – by which portfolio risk is reduced because it is spread over enough companies to ensure one specific company’s ups and downs will only have a limited effect on the rest of your portfolio. Many Australians only hold between seven and 15 companies.
Additionally, if investors only hold shares, they are ignoring other asset classes, the most common of which is bonds. Shares have a much higher chance of financial gain than bonds, but, equally, they have a much higher chance of loss. A portfolio without some bonds is likely to have periods of substantial losses.
Despite the long history of gold in this country, most Australian investors do not incorporate gold into their portfolios in any meaningful way. This is a potential oversight as the main properties of gold that make it so attractive in its physical form also lend themselves well to creating a portfolio with both lower risk and a better ability to withstand negative market moves.
