This article by Chris Brycki was originally published in the Australian Financial Review on May 14 2024: Why super funds are wrong on gold and how could this prove costly for Australians.
Why should I invest in gold?
Few assets stir as much debate and controversy as gold. While some financial giants, such as Warren Buffett, dismiss it for its lack of “utility value”, others, such as Ray Dalio, advocate for its inclusion in portfolios as a hedge against economic uncertainty.
Despite the ongoing discourse, most superannuation funds seem to be overlooking the potential benefits of gold, which surged to a record high of $US2400 (AU$3754) an ounce in April 2024, in their investment strategies.
Here are five reasons this oversight could prove costly in the coming decade.
Gold as a portfolio diversifier
The year 2022 posed challenges for traditional 60/40 portfolios, hinting at a potentially pivotal moment in the relationship between shares and bonds amid a sustained period of higher inflation. In this environment, gold has demonstrated remarkable resilience, echoing its performance during past inflationary eras, notably the 1970s.
A key reason for super funds to reconsider their stance on gold is its role as a diversifier. Unlike shares and bonds, which generate dividends and interest respectively, gold only offers capital appreciation. Its value lies in its ability to act as a diversifier, an insurance policy against currency devaluation, and a safe haven during times of market turbulence.
Modern portfolio theory underscores the importance of combining assets with low or negative correlations to reduce risk. Gold, with its historically low correlation to Australian shares, presents an opportunity to improve portfolio returns while minimising risk.
Unlike the more popular defensive alternatives for super funds, such as unlisted property and infrastructure, gold stands out not only for its low beta but also for its genuine negative correlation with Australian equities. Additionally, gold has demonstrated lower annual volatility compared to the S&P500 over 20 years, and boasts higher daily liquidity than most global equity markets.
Protection against stagflation
The increase in unit labour costs, coupled with the ongoing impacts of the energy transition, de-globalisation, and geopolitical tensions, points to a scenario where inflationary shocks may become more frequent. The RBA has also highlighted the potential for persistent services inflation and escalating rents to exacerbate inflationary pressures.
This trend should not be unexpected, as historical data reveals a pattern of inflation resurfacing in successive waves after initially surging above 7 per cent.
Gold’s significant outperformance during stagflationary periods in history such as the 1970s further emphasises its relevance in today’s economic context.
As central banks face inflationary pressures and rising geopolitical tensions, gold’s defensive attributes become even more valuable for investors aiming to safeguard their portfolios against potential risks.
Hedging against AUD devaluation
Gold also serves as an insurance policy against currency devaluation. In times when fiat currencies lose purchasing power due to economic instability or monetary policy, gold historically preserves the real value of wealth.
With the RBA grappling with the challenge of targeting inflation amidst high household debt levels, the risk of currency devaluation persists, making gold an appealing hedge for investors.
Despite the Australian dollar pricing out rate cuts in 2024, its persistent weakness suggests a lack of confidence in the economy sustaining higher interest rates, given the substantial level of household debt.
Aiding CPI+ return objectives
Super funds are subject to various performance measures, particularly the fund’s own target return for members (typically CPI plus 3 to 4 per cent over rolling annual periods).
The inclusion of gold could help meet this objective and protect the real value of members’ savings over time, particularly during extended stagnation periods when shares and bonds both underperform.
During the 1970s, diversified funds would have failed to reach even a modest CPI+ target without including gold in their allocation. If stagflation continues, this historical pattern may resurface, leading large super funds to depart from their real return objectives.
Central bank buying
Given the dire levels of global government debt, foreign central banks are prioritising enhancing the quality of their international reserves. Central banks have pivoted to being substantial buyers of gold over the past several years, leading to a rising percentage of gold ownership on their balance sheets. Interestingly, the downside volatility of US Treasuries has recently increased above that of gold, likely encouraging central banks to continue purchasing the metal.
Should gold maintain its outperformance over government bonds and real interest rates, as observed in 2024 thus far, it may trigger a reassessment of central bank portfolio allocations worldwide. This could lead to a further reallocation of assets from bonds and cash into gold.
Conclusion
Australia’s major super funds have overlooked a valuable opportunity by not allocating more to gold. Integrating gold into their investment strategies could bolster portfolio diversification, mitigate currency devaluation risks, and tap into the potential for superior returns during volatile market conditions.
Asset consultants who advise large super funds might avoid suggesting gold because it doesn’t align with their usual emphasis on actively managed products, which generate more research revenue for them. This conflict of interest could lead them to overlook the potential benefits of adding gold to super fund portfolios.
However, without embracing gold as a fundamental asset class, super funds may encounter challenges in meeting their investment objectives and serving the interests of their members over the coming decade.
