Guest Blog: All That Glitters Is Not Gold

On 15th February, the price of gold hit a six-month low of $1,608 per troy ounce, calling into question the precious metal’s credential as an all-weather asset class.

Contrary to widespread perception, gold has not been inflation proof.  But it has been a good hedge in periods of market turmoil, when investors have been forced to flee to safe-haven assets.

As recently as last December, many institutional investors, as well as high net worth individuals, had gold allocations as high as 15% percent – 20% in India. Even after the recent rally in the equity markets, many wealth advisors still continue to favour ‘return of capital’ over ‘return on capital.’ Their rationale has more to do with the worries about the other asset classes and less to do with gold’s intrinsic merit. For gold to succeed, evidently, it is enough for other asset classes to fail. Gold does not have to succeed in its own right.

This approach has served to conserve capital in periods of big dislocation, but it has come at a price. The implied rebalancing of portfolios requires good skills in market timing, which most investors and their advisors don’t have. Furthermore, gold investing is not like moving in and out of money market funds. The transaction costs can be hefty, even when using ETFs.

Worst of all, the overly defensive mentality behind gold investing often misses the bigger picture. This is made clear in the 2012 Principal Global Investors/CREATE survey “Innovation In the Age of Volatility.” Our report highlighted three scenarios for the Western economies over the next three years:  moderate growth (cited by 35% of respondents), muddle through (40%), and global deflation (25%). Research was taken in April 2012.

Since then, investor sentiment has improved, with decisive action by central banks on both sides of the Atlantic. Yet gold bugs continue to act as if the deflation scenario is the most likely one. That scenario reflected a minority view in our report – and that minority has gotten even smaller since then.

Investors would be well advised not to treat gold as a default option, but as an asset class in its own right like any other. That means shifting attention from relative valuation to absolute worth.

For sure, markets are still influenced more by politics than economics. But we’re beginning to see a semblance of normality where undue pessimism can inflict a heavy opportunity cost.

If investors remain nervous about global economic outlook, it makes sense to make a small allocation (maybe around 10%) to gold. But they need to realise that while gold works wonders against severe downdrafts, it is anything but risk free.