Gold Investing – Are The 7 Fundamental Drivers And Negative Real Rates Still Intact?

The latest investment research paper from the World Gold Council analyzes three topics in detail. The first part contains an in-depth analysis of the true relationship between gold and US real interest rates disproving common misconceptions and exploring gold’s portfolio performance during different interest rate environments. The second part is an examination of the seven primary factors influencing gold’s performance, including currencies, inflation, interest rates. The third part contains a study exploring the benefits of having gold as an integral component of retirement portfolios, focusing on the Mexican pension fund experience.

The content of each of the three topics is summarized below. We do not have sufficient rights to publish the paper here. The full version of the paper is available here.

Chapter 1: Gold and US interest rates: a reality check

As the US economy starts to show signs of rebalancing, paving the way for monetary policy normalisation, we explore the misconceptions surrounding the relationship gold has with real interest rates. We demonstrate that higher real rates are not unconditionally adverse for gold, as the effect of other factors needs to be considered. Thus, gold’s portfolio attributes are not compromised by a return to a normal interest rate environment. In addition, we find the influence US real interest rates have on gold has receded over the last few decades as demand has shifted from West to East.

Our analysis discusses the traditional link between gold, interest rates, and US investment markets and explains the different reasons why it changed over time: The global gold market has expanded and the supply and demand dynamics become more diverse. Gold is not only used as an investment tool in periods of low interest rates; it is also a consumer product that can be positively influenced by economic growth. The structural changes in the gold market, the remarkable recede of real rates’ importance and their economic impacts, and the increasing relevance of the demand from emerging markets are very likely to contribute to a shift of influence in determining gold prices.

Our analysis focuses on how real rates impact gold’s portfolio attributes such as returns, volatility and correlation. Each one of these attributes is a fundamental aspect of gold’s contribution in a portfolio. Our analysis further shows how a moderate real rate environment can be favourable to gold’s attribute

Chapter 2: What drives gold? Factors that influence the asset class and its role in a portfolio

To some investors, gold seems arcane: a non-productive asset that is simply extracted and stored. To many others, gold plays an important role as a store of wealth and portfolio risk management vehicle. To most, a key challenge is finding an appropriate framework of reference: what gold does, what it does not do, how and why it responds to various economic environments.

This paper sheds the light on the most common misconceptions about gold such as the exclusive use of US-driven factors in explaining its performance. Our analysis shows that gold’s performance can be understood in the context of seven primary interrelated global factors:

  • Currencies
  • Inflation
  • Interest rates
  • Consumer spending and income growth
  • Systemic and tail risks
  • Short-term investment flows
  • Supply-side drivers

The interaction and influence of these factors make gold a valuable portfolio component as a risk-management vehicle and a source of capital preservation.

Chapter 3: The role of gold in defined-contribution plans: Mexico case study

As more pension funds around the world opt for defined-contribution structures and move away from defined-benefit plans, contributors will not receive the same guaranteed payouts seen in the past. A comfortable retirement will be based on the combination of careful planning and a thoughtful investment strategy. Complementing absolute return performance with comprehensive portfolio risk management should become a foremost priority. Gold provides diversification and capital preservation for investors wishing to protect their nest egg.

With a growing defined-contribution pension system and one of most developed financial markets among developing economies, Mexico is a good example to illustrate the role of gold in retirement portfolios.

This paper analyses the benefits of adding gold to the typical Mexican pension fund portfolios (known as SIEFOREs). The study shows that optimal gold to allocations range between 1% and 7% (or 1% and 3% using conservative assumptions) depending on the asset mix of a portfolio. It finds that such allocations can reduce risk (as measured by volatility and Value-at-Risk) while maintaining equivalent expected returns, thus producing more efficient portfolios.

Download the full version of the paper here.

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