Gold: A Timeless Symbol of Wealth and Stability in Modern Investment Portfolios
Allure of gold
For many, gold is the ultimate currency. It is recognized all over the world with few exceptions. It intertwines the history of humankind from prehistoric times as a metal for foreign exchange, the early Iron Age as domestic coinage toward the modern age, and gold coins from Europe used as a standard currency before the US dollar. The US dollar now holds the same meaning in both international and domestic transactions as a reserve currency.
Gold is one of the many examples of commodity money. It has its merits – while barley used in ancient Sumer can rot or be spent, and iron has a tendency to rust and degrade, gold doesn’t. It holds its quality and can be recycled from other uses.
The long-lasting quality of gold and its visual appeal also increase its popularity and makes it the favourite metal in jewellery. Gold is particularly associated with weddings and extravaganzas, it’s also the main sign of wealth in parts of the world. Finally, gold is also heavily used in industry – it is used in semiconductor manufacturing as an electrical conduit and as a coating layer for high-quality audio cables. Space engineering also uses gold as an electric conductor because of its high resistance to adverse environments. And with all this demand, one thing is clear: There is only limited supply on earth – there are about 200 tonnes of mined gold and 50 tonnes of known unmined reserves.
History of gold as currency
The story of gold as a currency probably starts in ancient Greece in modern-day Turkey. As far as we know, the first gold coins were used in the 7th century BC in the kingdom of Lydia. In the coming centuries, the usage of metal coins (including gold) spread through neighbouring areas including the Persian daric and Athenian drachmas. Although Greek city-states often used a silver standard instead of gold, this form of currency prevailed, and its spread to other areas of the world was greatly helped by Alexander the Great and his conquests.
When we say silver or gold standard, it is good to remember that the first coins were made from electrum, which is an alloy of silver and gold. Only after that, the standard coinage changed to pure metals. The three competing standards of gold, silver, and bimetallism survived from ancient Greece to the late 19th century, when gold became the de facto world currency. Bimetallism is thought to be inherently unstable, however, as it presumes a fixed exchange rate between silver and gold guaranteed by the state, which results in arbitrage if the market prices and standard prices differ. Gresham’s law then states that “bad money drives out good money”, which results in people exchanging the less valuable metal for the more valuable in banks, storing the more valuable metal at home, and trying to spend only the less valuable one.
Most of the history we know about silver being used as a standard currency. From ancient Mesopotamia until the 20th century, people used silver which was more easily divisible into pieces worth less than a yearly wage compared to gold, however, the real standard shifted with a British move from silver sterling to gold sterling.
Paper money was originally introduced in Europe as a note certifying holdings of a certain amount with a goldsmith or a bank. Exchanging currency that way was much easier, gold (and silver) tend to be bulky, and heavy in large quantities and if one is to store it at home, it creates a need for higher security. It was much easier to store it with others with an institution that could distribute the costs of security between more people. As time progressed, gold became the standard behind money in banks, however, they were indeed not made from gold anymore. We are in the late 19th century or early 20th, and the banking sector is now a large slightly regulated presence in Europe and the USA alike. Governments tend to suspend and resume the convertibility of money to gold depending on their circumstances, especially in wars like the Civil War in the US or World War I.
In the late 1920s, economies around the world felt the pain of having to deal with panics and downturns without being able to offset them with money. According to economists like Bernanke, the rigidity of the gold standard created and prolonged the Great Depression as there was no way to increase the money supply and prevent deflation and depression (without devaluation, which was a step eventually taken by almost all central banks). With prices lowering and debt staying the same, many loans became in effect under-collateralized and lenders were at risk of bankruptcy. (That might not be the worst thing, but at the time, it did help destabilise the financial world.) The gold standard was eventually abandoned in the late 1930s and reinstated in the form of the Bretton-Wood system in 1944.
Bretton-Wood ensured the convertibility of US dollars into gold – however only between governments and central banks (if they were separated), not for citizens. Other currencies were to be pegged against the dollar, which made the US the obvious trading partner for most countries participating in the system (which might have been the motivation behind it). Over time many countries devalued their currency (both Britain and Germany devalued their currency twice) which left the USA in an unfavourable position.
Reacting to the geopolitical situation, France decided not to diminish dollar reserves and increase gold reserves, which resulted in pressure on the gold/dollar rate and diminished US influence in the First World. The rigidity of the system created problems for exporters and encouraged imports and in the end, resulted in a temporary halt in gold conversion, revaluation of US dollar value to gold, and eventually letting the US dollar float according to market. Thus ended the gold standard in its entirety.
Currently gold holds the sentimental role of a stable currency and – as it were – a gold standard of economic policy in a nostalgic reinterpretation of economic history. Especially for those who remember times of high inflation (the 1970s in the USA, 1980s in Italy, 1990s in the East bloc, 2020s in Turkey and most of the world) look toward gold and other commodities as a stable anti-inflationary currency that could prevent high inflation (with some justification).
Real-world demand for gold
Every year between 3 and 4 thousand tonnes of gold are mined, 1200 tonnes are recycled from previous uses and 4000 tonnes of gold are bought. What happens to this gold? Who uses it, and who demands it?
About half of the sold gold is in the form of jewellery. The cultural significance of precious metals is still strong in both Western and Eastern societies, where gold rings are often used in engagements and weddings as a token and promise of everlasting relationship (as everlasting as gold is). In China and India, particularly gold jewellery is a status symbol and these countries alone make up over half of the world’s demand for gold in jewellery.
Gold is heavily demanded by the electronics industry, where for every high-end PCB (printed circuit board) there needs to be a small amount of gold present. Electronic systems in both automotive and AI rely on quality heat and electric current conductivity, thus creating higher demand for example for EV production. Another industrial application is LED lights, 5G, and WiFi chips and memory.
Central banks around the world are buying up gold reserves as well, with demand elevated compared to decades earlier. One of the possible reasons for pent-up demand for gold by banks is risk mitigation from possible sanctions, as was seen in 2022. Gold in reserves serves potentially the same purpose as foreign currency (if not invested), therefore gold holding is somewhat justified.
A large big source of demand is from investors especially from China, India, and Turkey – for both cultural and economic reasons. While gold investments (in the form of gold bricks and coins) are often given as gifts if small enough, professional investors created structures in which to invest without burdening themselves with problems like storage. Gold ETFs are available precisely because no small investor wants to deal with the security being tight enough to accommodate gold in a personal vault. That is why institutions buy and hold gold for their investors.
Different ways to own and invest in gold
If you are set on investing in gold, there are a couple of considerations: Do I want to be able to carry my wealth with me? Am I comfortable with letting institutions control my investments? Do I trust any institutions? Am I digitally minded? What is my appetite for risk? And so on… Actually, those questions should be answered with every investment even into real estate.
If one values the ability to live with their wealth, physical gold is a great idea. National governments often sell their commemorative coins, gold bars are always available somewhere to buy and one can never forget about jewellery (discussed before), which has as one of the few investments the potential to elevate your social status by itself.
If you are a little bit more flexible on the “real side” of the trade, you can participate in a gold savings plan. You basically send your regular payments to a broker who then carefully sources the gold and holds it for you. If you decide to end the savings plan, you can withdraw your gold and sell it to the plan manager.
Probably the best investment into gold if you do not need to physically hold it is gold ETF. The most popular funds in this regard are SPDR Gold shares from the World Gold Council and iShares Gold Trust from BlackRock. Both of these funds (and numerous others) buy physical gold and store it in designated vaults, therefore after accounting for expenses ranging usually from 0.25% to 0.5%, these funds reliably follow the price of gold on the spot market.
With lower liquidity and slightly higher expense ratios, mutual funds are not as popular as they used to be compared to ETFs, however, some institutions offer gold mutual funds. If you have access to one, you might be able to invest from comparatively lower sums than when buying one whole share of ETF. Most funds (both mutual and ETFs) invest in physical gold, however, there are funds investing in gold via derivatives.
This might be interesting for the more advantageous investors. A fund investing in futures buys a contract for buying gold at a specified price in the future (for example February next year) and participates in loss/gain on the change of price at the time. Option strategy allows this fund to construct a directional bet on price movement, therefore betting that the price of gold will rise or fall at a certain pace. Those derivative contracts are also available to small investors, who can for example buy a futures contract (That obliges them to pay at a certain time and take delivery) and sell it before its due date, therefore participating in the price movement of gold without taking the actual gold into inventory. However, trading in derivatives is more complex and riskier than investing in funds or buying physical gold, so bear that in mind.
Another way to invest in gold is by taking a position on the production side rather than the metal side of the equation. There are scores of companies mining and producing gold, many of whom are covered by specialised sector ETFs for gold miners. The main reason for buying either individual stock or funds is that gold in itself doesn’t produce income, however, businesses do.
Reasons to invest in companies are, of course, numerous. If you are about to invest in gold mining, you have to not only consider the state of the gold market (which they produce) and the state of the economy (which they are of course impacted by, because they need labour and capital) but also state of the stock market. That means that while gold mining funds are correlated with gold prices, they are also correlated with the stock market and has to either bear that risk, be careful in choosing actual stocks to invest to or stick with investing in simple gold.
The newest way to invest in gold is by using digital tokens. After the crypto boom in the late 2010s, many companies started to tokenize physical objects. Currently, there are more tokens representing gold, however the probably most famous are Tether Gold and Pax Gold. While both claim to have numerous advantages compared to either owning gold or a gold-owning fund, the only at the moment relevant advantage is in user experience and low time-to-settle on crypto exchanges.
Impact on portfolio and usage in normal diversified portfolios
Who invests in gold, anyway? There are two main reasons to invest in gold: You either believe everything is going to crash and only gold will hold value, or you are trying to diversify your holdings for events like a crash or inflation. Let’s concentrate on the latter.
First of all, gold is considered a “Safe haven” and therefore is a target of funds flowing out of other asset classes (stocks and bonds mainly) during crises. Dirk Baur and Lee Smales found a positive correlation between changes in perceived geopolitical risk and the price of gold, even when accounting for other interfering financial variables such as changes in industrial production or credit spreads (difference between ratings of Aaa and Baa rated bonds) and term premiums (difference between 2-year and 10-year treasuries). They also found that the correlation is explained by a fear of geopolitical risk and not the actual events.
There is a low correlation between stock indexes and gold prices, although the precise correlation differs depending on the geography and risk inherent to the stock market (stock markets with lower valuations might be less volatile in crises).
If you consider adding gold to your portfolio, you have to decide on allocation size. Depending on which philosophy you follow, you might want to add 5%, 7.5% (as does Ray Dalio), 20 % as in Golden Butterfly or even higher up to 48.5%, if you are trying to maximize Sharpe Ratio (average returns normalized to standard deviation). There are of course many other more obscure – even Talmudic – or niche portfolio constructions which you can test for yourself.
From Portfolio Visualizer, you can see that gold has a low correlation with all standard assets, with exception of precious metals (of which it is subcategory) and perhaps global bonds and TIPS. This is partly because gold demand rises in times of inflation as do yields on TIPS and FX income from unhedged bonds.
As for portfolio protection, it is believed by investors as a safe haven. However, the efficacy is disputed by Mark Spitznagel – who wrote a book on the subject of safe havens. He reckons that even though gold is relatively stable and in the 70s to 80s did help overall portfolio performance (in 80:20 stock to gold model), this behavior is unstable and in later years did not help. That means that to be effective, one has to take an active approach to gold and size the allocation depending on the regime in which one is (real rates and inflation are crucial in the performance of gold regarding other assets). And he suggests a different approach to ensuring good and stable returns in the form of derivatives.
Out of all other possible investments, gold does have a high correlation with precious metals, especially silver. Another one is platinum, with a correlation coefficient slightly above 0.5. Not surprisingly Precious Metal index has an extremely high correlation with gold price since gold constitutes about 90% of the index. Where investors can gain more diversification is in energy commodities, stocks, and REITs.
Regarding the so-called “Digital gold” (Bitcoin), its correlation to gold is slightly under 0.1, however, that comes with extremely high volatility and therefore risk in a portfolio. That, of course, implies higher potential for return (given how often BTC breaks its all-time high numbers), which is on what exchange-traded product from Bytetree BOLD is betting on and does invest in a mix of gold and BTC (weighted by inverse-volatility): In recent few years this product had slightly higher returns than gold or stocks, however given its age and given the fact that past performance is not a guarantee of future results, this product and strategy should still be considered as highly speculative.
Gold as an investment has its limits. It definitely isn’t the cure-all “gold bugs” such as Peter Shiff make it to be. Investing in gold makes you forego any potential yield. It is hard to actually value it, and you can’t use any usual techniques such as earnings multiple (no earnings) or discounted cash flow (no cash flows from holding gold). There is an opportunity cost of not investing in higher-yielding assets, depending on your choice of investment vehicle there might be other associated costs with storing gold.
But it’s gold. It might not be right for your investment and even if it is the right asset for your portfolio, it might occupy just a tiny portion of it. But its history and endurance warrant a look.
