Key Takeaways
- For investors with long time horizons, like many institutions, gold’s differentiated risk-return characteristics have enabled it to maintain its real value across disparate macroeconomic environments and through existential disruptions to markets, a feat we consider truly rare.
- Institutional investors seeking the potential hedging features of gold may find different levels of exposure and different asset mixes suitable, depending on their risk-return objectives and macroeconomic and market expectations.
- First Eagle’s Global Value team views bullion and gold-related equities as complementary methods to gaining gold exposure. We actively but patiently manage our relative allocations to gold bullion and gold stocks from the bottom up.
- Given the inherent uncertainty of the gold market and the many complex factors that drive its movement, we believe a strategic allocation to gold in certain of our portfolios is the most compelling way to gain exposure to its characteristics as a potential hedge against adverse market conditions.
Driven by our belief that the permanent impairment of capital is the greatest risk facing investors over the long term, gold serves as a long-duration potential hedge that we believe can provide portfolios with a source of resilience across a wide variety of adverse circumstances— including both inflationary and deflationary environments as well as equity bear markets and sharp near-term selloffs—while also supporting real purchasing power across market cycles.
After decades of persistently low interest rates and periodic bouts of extraordinary stimulus, recent years have been marked by the emergence of a decidedly less accommodative policy regime. Amid tighter financial conditions, investors today also face a litany of acute risks, including massive sovereign debt levels, ongoing fiat currency debasement, complex political and geopolitical dynamics, and general systemic fragility—all of which we believe highlight the value of a potential hedge like gold.
Despite what we believe is a compelling use case for gold, the percentage of institutional investors with a strategic allocation to gold and gold-related securities remains relatively low; a recent survey of 400-plus institutional investors found that only about 15{3da602ca2e5ba97d747a870ebcce8c95d74f6ad8c291505a4dfd45401c18df38} owned gold.1 Our conversations with institutional clients and consultants have revealed increased interest in the metal, however, and this paper responds to some of the questions we are asked most frequently when discussing gold and its application in institutional portfolios.
Q: How can institutional portfolios potentially benefit from gold?
We believe the differentiated risk-return characteristics of gold make it a potential all-weather hedge against a variety of market, macroeconomic and geopolitical disruptions, as well as a store of value across these same conditions. With a low correlation to most major asset classes since 1971— when it began to trade freely following the collapse of the Bretton Woods system—gold historically has served as a diversifying complement to portfolios under a range of circumstances and has been supportive of long-term investment, based on our research.
The most recent edition of the biannual survey of institutional investors performed by Coalition Greenwich and the World Gold Council found that only about 15{3da602ca2e5ba97d747a870ebcce8c95d74f6ad8c291505a4dfd45401c18df38} of the 400-plus investors surveyed owned gold, though those that did had an average allocation of 4{3da602ca2e5ba97d747a870ebcce8c95d74f6ad8c291505a4dfd45401c18df38} and the vast majority expected to increase or maintain what they viewed as a strategic allocation. Of the gold owners, more than 85{3da602ca2e5ba97d747a870ebcce8c95d74f6ad8c291505a4dfd45401c18df38} cited its diversification potential as the reason they hold it, with more than 70{3da602ca2e5ba97d747a870ebcce8c95d74f6ad8c291505a4dfd45401c18df38} saying that its value as a potential inflation hedge drove their positioning.
Q: Should gold be viewed as a potential hedge against inflation or against tail risk? How does it compare with other potential hedges?
For long-term investors, gold has maintained its real value across disparate macroeconomic environments and through existential disruptions to markets, a truly rare feat in our view. Over the past two centuries alone, gold has withstood inflationary episodes and deflationary spirals, political revolutions and rapid technological evolution, localized conflicts and world wars, pandemics and treatments for them.
Unlike other commodities and real assets that investors may consider for their inflation-hedging potential—such as copper, oil, silver and platinum—gold has limited industrial application and thus virtually no beta to business activity, as shown in Exhibit 1. While these assets share gold’s relative limited supply and history of retaining their real value during periods of inflation as the value of fiat declines, their sensitivity to economic activity impairs their reliability as hedges in periods of economic weakness and/or deflation.
Gold’s qualities also are differentiated from financial assets that investors often consider as potential hedges. Massive levels of sovereign debt in the developed world have significantly increased the risk government bonds now carry even as both nominal and real yields have returned to levels not seen since the global financial crisis of the mid-2000s, while structural issues also impair the use of government bonds as a long-duration potential hedge. Options and other derivatives contracts are another financial alternative but come with their own set of limitations, including implementation expense, relatively limited liquidity and counterparty risk.
Cryptocurrencies are another asset class that in recent years has entered the potential hedge discussion—so much so that many of its backers refer to bitcoin, the world’s largest cryptocurrency by far in terms of market value and trading volume, as “digital gold.”2 For all of their broadening appeal, cryptocurrencies represent a very young asset whose behaviors across varying macroeconomic and market regimes are theoretical at best; in our view, they can be more accurately described as an option on becoming digital gold. In contrast, actual gold has served as a store of value for millennia, and its differentiated risk-return characteristics have enabled it to maintain its real purchasing power over time across disparate environments and through numerous existential threats, providing investors a perceived “safe haven” in times of need.
In terms of tail risk, gold’s countercyclical tendencies have been particularly evident during periods of extreme equity market distress; gold’s history as a perceived “safe haven” asset is illustrated in Exhibit 2.
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