GOLD AS PART OF A BALANCED INVESTMENT PORTFOLIO

Transcription

1 May 2012 Gld has tw significant shrtcmings, being neither f much use nr prcreative. True, gld has sme industrial and decrative utility, but the demand fr these purpses is bth limited and incapable f saking up new prductin. Meanwhile, if yu wn ne unce f gld fr an eternity, yu will still wn ne unce at its end. - Warren Buffett, Frtune, 12 February 2012 The inclusin f gld bullin reduces bth the expected return and the vlatility in the investment returns This reductin in vlatility als causes a reductin in the prbability that the investment return is belw a particular figure that may be deemed by trustees r investrs t be unreasnable, unacceptable r indicative f a high level f risk - Dr David Knx, PwC Actuarial, 2002 Overview Respnding t the severe market shcks f the glbal financial crisis (GFC), investrs are increasingly being attracted t alternative assets, and t gld in particular. In fact, the price f gld has dubled ver the last 3 years seemingly indicating that investrs believe that gld can be a valuable cmpnent f an investment prtfli during perids f vlatility. But just hw real are the prtfli benefits f investing in gld? Because gld desn t lend itself t valuatin using nrmal techniques (eg it desn t prduce a future cash flw which can be valued), it is susceptible t criticism as an asset whse value is primarily derived frm speculatin. Gld bugs advcate hlding gld at all times, and gld skeptics cunter by likening gld t a bubble asset (where the value t an early investr is increasingly driven by greed and fear led investment frm subsequent investrs). Given the increasingly significant central bank investment in gld since the GFC, and the recent explicit allcatins being included in several research huses mdel prtflis, sme real value fr gld des seem t exist, suggesting that the simplistic lve r hate fr gld may be verly superficial. T help reslve these questins, in the last decade several academic studies have attempted t identify the value drivers fr the price f gld, and als t evaluate the rle f gld in a diversified prtfli. Knx (2002) cncluded that gld is a valuable cmpnent f an Australian diversified prtfli, especially as a dampener against adverse market cnditins. Mre recently, a detailed study cnducted by Oxfrd Ecnmics (2012) has tabulated the diverse range f inputs t the price f gld, and used these t build a valuatin mdel. Applying that mdel t a range f pssible future ecnmic scenaris, the Oxfrd Ecnmics paper indicates that gld may prvide an imprtant additin t a prtfli in the case f glbal deflatin, inflatin, r stagflatin. Bth studies als shw that gld may nt be an imprtant part f the prtfli if ecnmic cnditins are benign r display cnsistent grwth. The investment wrth f gld can be mdeled and valued TABLE 1: expected relative perfrmance f gld in varius market cnditins. Gld can add prtfli value in a number f different market cnditins Surce: Oxfrd Ecnmics. Future results are nt guaranteed In this research paper we utline the key cmpnents f the value f gld and illustrate the prtfli impact f including an allcatin t gld in an investment prtfli. We shw that gld can add value t an Australian investment prtfli. We als assess the merit f hedging the crss currency risk fr Australian investrs, and cnclude with a brief discussin f the BetaShares Gld Bullin ETF, (ASX Cde: QAU). 1

2 Executive Summary In research cnducted by Oxfrd Ecnmics (2012) a detailed analysis f the varius inputs t and drivers f the perfrmance f gld ver an extended histrical perid was used t build a frward lking mdel which can be used t illustrate the likely perfrmance under a range f scenaris. This study is a serius and credible attempt t analyse the value f gld, in light f the shrtcmings f the traditinal securities analysis f incme prducing assets (which is therefre unable t mdel the value f gld). Put simply, the Oxfrd Ecnmics research shwed that gld wuld underperfrm assets like equities in a benign/ grwth envirnment, but wuld add significant prtfli benefits in deflatinary, inflatinary and stagflatinary ecnmic cnditins. The Oxfrd Ecnmics paper als mdeled the prtfli cnstructin benefits f gld in a bradly diversified prtfli, and recmmended the inclusin f a 5% allcatin t gld in a balanced prtfli. Gld can add prtfli value in deflatinary, inflatinary and stagflatinary markets In Knx (2002) a variety f Australian prtfli cnstructin metrics were used t determine the benefits f including a cmpnent f gld in a bradly diversified prtfli. Knx analyses the prtfli benefits histrically using knwn data, and then develps a frward lking mdel t assess the cnditins in which gld will be useful t prtflis ging frward. Detail f the methdlgy and assumptins will be cnsidered in mre detail in fllwing sectins. The cre prtfli cnstructin findings in Knx (2002, p.13) are: Fr the intrductin f gld wuld have reduced the return by apprximately 0.1% - 0.2% pa fr each 1% investment in gld bullin. Hwever, in mst cases the vlatility wuld als have reduced ; Fr the intrductin f gld bullin has virtually n impact n the prtfli return but reduces the vlatility measure in every case. Imprtantly, Knx states clearly that fr the histrical review, gld was uncrrelated with all ther majr asset classes (an imprtant factr in perids f market vlatility): The crrelatin c-efficients f investment returns frm gld bullin with all ther asset classes are slightly negative r clse t zer; Gld bullin has characteristics in terms f risk and return that suggest that it is very different frm all ther asset classes (Knx, 2002, p. 22). Gld has negative r lw crrelatin with ther asset classes In the frward lking analysis, Knx finds bradly similar results applying: The inclusin f gld bullin reduces bth the expected return and the vlatility in the investment returns; This reductin in vlatility als causes a reductin in the prbability that the investment return is belw a particular figure that may be deemed by trustees r investrs t be unreasnable, unacceptable r indicative f a high level f risk (Knx, 2002, p. 26). (Emphasis added) These findings are in line with the Oxfrd Ecnmics research which indicates that the Knx findings still hld true. Fr Australian investrs, we have mdeled the prtfli benefit f including a 5% expsure t physical gld bullin (with the A$/US$ exchange rate hedged) see Chart 1 belw. In this example, we blended a 5% allcatin t physical gld bullin (currency hedged) with a 95% allcatin t the return f the Mercer Whlesale Balanced Grwth Fund. Chart 1 shws the verall return f the blended prtfli, and Chart 2 shws the mdified risk/return prfile f the blended prtfli. These charts shw that including a 5% allcatin t the BetaShares Gld Bullin ETF, (ASX:QAU), wuld have imprved the return and lwered the verall prtfli risk ver ten years ending December This is in line with the findings f Knx (2002) that gld can prvide a real surce f prtfli diversificatin. Gld can reduce prtfli vlatility Inclusin f 5% gld in a diversified prtfli 2

3 CHART 1: RETURN OF BLENDED PORTFOLIO WITH INCLUSION OF 5% ALLOCATION TO QAU 5% allcatin t gld wuld have imprved the return and lwered the risk t a balanced prtfli ver last 10 years Surce: Mercer, BetaShares Capital Limited. QAU perfrmance is simulated and represents the perfrmance f the spt price f gld bullin with a currency hedge against mvements in the AUD/USD exchange rate (which QAU aims t track). Past perfrmance, simulated r actual, is nt a reliable indicatin f future perfrmance and des nt take int accunt QAU s management csts, which wuld reduce QAU s returns by apprximately 0.59% per annum. CHART 2: RISK/RETURN OF BLENDED PORTFOLIO WITH INCLUSION OF 5% ALLOCATION TO QAU Surce: Mercer, BetaShares Capital Limited. QAU perfrmance is simulated and represents the perfrmance f the spt price f gld bullin with a currency hedge against mvements in the AUD/USD exchange rate (which QAU aims t track). Past perfrmance, simulated r actual, is nt a reliable indicatin f future perfrmance and des nt take int accunt QAU s management csts, which wuld reduce QAU s returns by apprximately 0.59% per annum. 3

4 What are the current drivers f the value f gld? Understanding the difference between nrmal assets which prduce a future return, and an asset like gld which des nt prduce a future return, is the key t understanding the value f gld. Additinally, the durability f gld cmpared t ther assets which waste/ deterirate r are cnsumed, is anther driver f the value f gld. Fr example, apart frm the 10% f current demand fr gld frm industrial users which use the gld in cmpnents r prcesses which deterirate ver time the majrity inputs t the value f gld aren t directly linked t the changing supply and demand f the business cycle: As a result, gld prices lack the strng link t the ecnmic cycle that ther cmmdities have and gld has thus ften exhibited lw r even negative crrelatins with these and ther financial assets. Gld is als unusual amng financial assets in nt delivering a yield, e.g. a dividend r cupn as paid by equities and bnds and this can be seen a disincentive t hld gld; hwever, gld has a significant advantage cmpared t sme ther financial assets which is its lack f default risk. (Oxfrd Ecnmics, 2012, p. 5) Gld des nt have a default risk, unlike nrmal financial assets The cncept f securities valuatin was cnceived as a thery which was based n and seemed t reflect the actual wrkings f the securities market. Because gld isn t susceptible t this valuatin methd, it has suffered frm criticism as a speculative and smetimes vlatile investment. As a result, a number f academic research prjects have been undertaken in an attempt t build a reliable valuatin mdel fr gld. These add a layer f analytical rigur beynd the empirical prtfli research f the srt cnducted by Knx (2002). The mst recent f these research prjects was cnducted by Oxfrd Ecnmics in The Oxfrd Ecnmics research is useful fr its summary f the findings f previus similar research prjects, as well as fr its debunking f sme ppular myths. The authrs nte that gld hasn t always behaved in line with inflatin despite the typical belief that gld is an inflatin hedge because f its relative price stability ver time. They adpt the view that there are multiple inputs t the price and value f gld, mre than simply being an inflatin hedge. Fr example, gld rse t mre than 3x its lng term average price during the 1980s and then fell well belw its lng run average price during the 1990s. These swings were far wider than wuld be explained thrugh a simple link between gld and inflatin. S what are the inputs t the price f gld? Real interest rates impact the price f gld because as rates rise the pprtunity cst f hlding gld als rises, and vice versa, lw real interest rates make gld mre attractive t hld; Building a valuatin mdel fr gld Main factrs driving the value f gld The value f the US$ typically mves inversely with the price f gld. Since exchange rates were flated in the 1970s, several studies have tracked the link between the US$ and gld, including the IMF. The ratinale fr the inverse link between the price f gld and the US$ is that: A falling dllar increases the purchasing pwer f nn-dllar area cuntries (and a rising dllar reduces it) driving up prices f cmmdities including gld (r driving them dwn in case f a strnger dllar) In perids f dllar weakness, investrs lk fr an alternative stre f value, driving up gld prices. This includes dllar-based investrs cncerned abut pssible inflatinary cnsequences f a weak dllar. In strng dllar perids the dllar itself is ften seen as an apprpriate stre f value. (Oxfrd Ecnmics, 2012, p. 8). Financial stress drives up the price f gld. This is because f a number f factrs: Cncerns abut the default risk fr nrmal investments like bnds and shares rises in perids f financial stress; The liquidity in the gld market becmes mre attractive when illiquidity rises in traditinal markets; The lw t negative crrelatin between gld and ther asset prices highlights its value as a stre f wealth which is highly attractive during stress perids. 1 The Impact f Inflatin and Deflatin n the case fr Gld (Oxfrd Ecnmics, 2012). 4

5 Rising plitical instability als links t the price f gld, being seen in the rising gld price after the Iranian revlutin and the Sviet invasin f Afghanistan in the 1970s and 1980s, and the aftermath f the September 11 terrr attacks n the USA; Official sectr activity (gvernments, central banks, svereign wealth funds) has a material impact n the gld price. As at 2010, the sectr held glbally 30,500 tns, which was 15% f ttal abve grund reserves (Oxfrd Ecnmics, 2012, p. 11). The grwth in fficial reserves in the 2000s was led by the emerging markets (many f which mved int trade and current accunt surpluses during the 2000s) and fllwed by develped natins after the GFC. Net central bank buying f gld was 73 tnnes in 2010 and 77 tnnes in 2011; Quantitative easing has cincided with a sharply rising gld price. The simplest explanatin f this is that the value f the paper mney with which gld is purchased has fallen as a result f the deliberate debasement f the US$ and Eur (the latter implements quantitative easing thrugh measures such as the LTRO). The impact f increased liquidity within the glbal mnetary system since the GFC has nt yet triggered strng inflatin, but it is widely expected that this risk culd materialise when and if the banking system is repaired (and becmes a better transmissin system f liquidity int the brader ecnmies). The link between quantitative easing and the gld price may be seen in Chart 3: chart 3: Gld price and US Mnetary Plicy. Surce: Oxfrd Ecnmics, 2002, p.12. The Oxfrd Ecnmics research cmbined each f these bserved value drivers fr gld int a pricing mdel, which was tested against the actual price behaviur f gld ver time and fund t be an accurate reflectin f previus price mvements. Chart 4 shws the utcme f this testing, which suggests that the mdel shuld be a rbust determinant f the future value and price behaviur f gld. chart 4: Actual and mdeled values f gld. Surce: Oxfrd Ecnmics, 2002, p.15. 5

6 Pst GFC drivers f the gld price Applying this mdel t decmpse the large rise in the price f gld since the GFC, Oxfrd Ecnmics suggests that there are 3 main factrs currently driving the price, with sme subsidiary factrs als cntributing: The depreciatin f the effective dllar exchange rate The recent financial crisis, which raised financial stress levels Mst recently the Federal Reserve s quantitative easing plicy, which has raised fears ver medium term inflatin (Oxfrd Ecnmics, 2012, p.16) These findings are cre t the prspects fr the gld price in the near t medium term. Let s nw lk at the prspects fr the gld price under the three mst likely ecnmic scenaris ver the next few years. Depending n which view the investr has will indicate the benefit/ rle that gld can play in the investr s prtfli. The results are shwn in Chart 5 belw: Quantitative easing impacts the value f gld chart 5: expected relative perfrmance f gld under varius market cnditins Surce: Oxfrd Ecnmics, 2012, p. 18 Future results are nt guaranteed. Gld under varius future ecnmic cnditins The Benign scenari Assuming the glbal recvery cntinues, ie that any further banking system crises are relatively small and well cntained, and that glbal ecnmic grwth is maintained, the Oxfrd Ecnmics mdel predicts that gld wuld be a relatively weak cntributr t prtfli returns. Grwth assets like shares and prperty shuld prvide better returns in this scenari. The Deflatinary scenari In the event f cntinued instability in the glbal financial system, with peripheral Eurpean banking and svereign defaults (eg Spain, Prtugal, etc), the likely impact is a deflatinary envirnment (triggered by massive withdrawals f liquidity frm the system, respnded t by further debasement f the mnetary systems thrugh expanded quantitative easing). In this deflatinary scenari, gld is an imprtant part f the investment prtfli, with expected returns better than shares and prperty but behind the returns frm bnds and cash. Gld is expected t add value in a deflatinary envirnment The Inflatinary scenari Inflatin is the usual respnse t lse mnetary plicy. Lse mnetary plicy in the US fllwing September 11 and the tech wreck is linked t the rising asset price inflatin in the mid t late 2000s. The cncern is that this rising inflatin might be repeated in the near t medium future which culd happen if ecnmic recvery accelerates and liquidity isn t withdrawn in pace with the recvery. Gld is the best perfrming asset in the Oxfrd Ecnmics mdel in the inflatinary mdel, fllwed by equities. Bnds are the wrst perfrmer, as the return f capital at maturity desn t match the rising cst f real assets. Gld is expected t utperfrm ther assets under inflatinary cnditins 6

7 The Stagflatinary scenari The stagflatinary scenari cntemplates that a sharp il price rise (t US$150 per galln) triggers sharp increases in inflatin, which turn int a wages and price spiral as wrkers demand higher wages t cmpensate fr rising csts prmpting cmpanies t increase prices t cmpensate fr higher csts, etc. Interest rates rise t dampen inflatin and this in turn intrduces recessinary cnditins, with a gradual return t ecnmic grwth and lwer inflatin several years later. The prspect f an il price spike rises with geplitical instability, especially in the Middle East. Pssible Iran/Israel cnflict is ne ptential trigger fr this scenari. In the stagflatinary envirnment, in the Oxfrd Ecnmics mdel, gld perfrms better than bnds but behind equities, cash and prperty. The rle f currency hedging fr Australian gld investrs Based n the findings f Knx (2002) and Oxfrd Ecnmics (2012) we can cnclude that there is a plausible basis fr the inclusin f 5% f gld bullin in a bradly diversified investment prtfli. Investrs hlding a strng psitive view f glbal and Australian ecnmic cnditins may nt be inclined t hld this level f gld, but investrs with a less benign investment utlk will find strng supprt in these findings fr hlding at least a 5% allcatin t gld. Australian investrs can chse frm a number f different methds fr hlding gld: Physical gld bullin (where gld cins r bars are held fr the investr, with strage csts applying, and where existing investrs wishing t sell need t be matched against incming buyers); ASX listed structured prducts which give expsure t physical gld bullin r use derivatives t btain that expsure (typically the reference price fr these structured prducts is US$, such that the investr has an A$/US$ exchange rate risk); ASX listed ETFs such as the BetaShares Gld Bullin ETF (ASX cde: QAU), which is backed by physical gld bullin, and which als hedges the crss currency risk using a simple mechanism f buying 1 mnth A$/US$ frward cntracts. As shwn abve, the price f gld typically mves inversely with the US$. That makes currency a serius and significant cmpnent f the case fr an Australian investment in gld. Buying physical gld and ASX listed structured prducts where the crss-currency risk isn t hedged can and has detracted frm the price perfrmance f gld t Australian investrs. Chart 6 belw shws that an investment in gld after the GFC has been a prudent and psitive result, but als shws that ding s withut hedging the currency risk has generated a strng under-perfrmance cmpared t an investment in gld where the crss-currency risk has been hedged (eg as with QAU). Hedging the A$/US$ exchange rate can add value t Australian gld investrs chart 6: Gld Bullin Spt Price Perfrmance A$ Hedged v Unhedged: 1 January December gld Bullin Spt Price (A$ hedged) gld Bullin Spt Price (Unhedged) % % dec-08 mar-09 Jun-09 Sep-09 dec-09 mar-10 Jun-10 Sep-10 dec-10 mar-11 Jun-11 Sep-11 Surce: Blmberg, BetaShares Capital Limited. Past perfrmance is nt an indicatr f future perfrmance. 7

8 The A$ has significantly appreciated against mst majr currencies, including the US$, since the GFC. This is because f the strength f the Australian ecnmy (buyed by a psitive terms f trade) and the related high A$ interest rates. As the prspects fr the Australian ecnmy have mderated smewhat in recent times cmpared t the slightly imprving US ecnmy and as A$ interest rates have started t mderate, the A$ has fallen against the US$. Typically this culd be seen as an indicatr that hedging the A$/US$ exchange rate wuld nt be sensible in the expectatin that the gains in hlding gld culd be undermined by a falling A$ (against the US$). Clser scrutiny suggests that this utlk may be verly simplistic. Chart 7 belw shws that during the first few mnths in 2012, when the A$ has fallen against the US$ (ie the US$ has appreciated), s t has the price f gld. chart 7: Cmparative price perfrmance f BetaShares Gld Bullin ETF (ASX: QAU vs GOLD - an unhedged gld exchange traded prduct listed n ASX vs A$/US$ exchange rate, 30 December 2011 t 30 March Surce: Blmberg, BetaShares Capital Limited. Past perfrmance is nt an indicatr f future perfrmance. This is in line with the histrically bserved inverse crrelatin between the US$ and the price f gld. In essence, as the US$ has risen in real terms during the start f 2012 essentially reflecting an increasingly benign utlk fr the US ecnmy the price f gld has fallen. This is in line with the Oxfrd Ecnmics research which has mdeled that the cmparative perfrmance f gld cmpared t ther assets in benign t grwth ecnmic cnditins generally falls when equities rally. A pssible cnclusin frm this is that, unless an investr has a benign utlk fr the glbal recvery (in which case an allcatin t gld may nt be attractive), it is ratinal fr Australian investrs t hld an allcatin t gld and t hedge the A$/US$ exchange rate risk. This is because the appreciatin in US$ against the A$ that has been experienced recently reflecting an increasingly psitive US and glbal ecnmic utlk wuld nt be expected t be maintained in the event f a slwdwn r deteriratin in the US ecnmy. A sharp external shck culd trigger a shrt term rally in the US$ (as a safe haven ) but wuld be expected t be fllwed by further expansin f the US (and prbably Eurpean) mney supply thrugh additinal quantitative easing. Further debasement f the US$ via quantitative easing wuld be expected t trigger the cntinued decline/weakness f the US$. In these cnditins, ie further market instability leading t a deflatinary, inflatinary r stagflatinary envirnment hlding an allcatin t gld wuld be in line with the apprach utlined in Knx (2002) and Oxfrd Ecnmics (2012); and hedging the A$/US$ crss currency risk is cnsistent with the investment ratinale fr hlding gld in thse scenaris. 8

9 Cnclusin In this research paper we have canvassed the varius theries (fr and against) the case fr including a cmpnent f gld bullin in a diversified prtfli. Despite the criticism frm traditinal securities analysts that gld prduces n incme and is therefre nt capable f ratinal valuatin, we have identified a number f studies (eg Knx (2002) and Oxfrd Ecnmics (2011) which have frmulated an apprach t valuatin and prtfli cnstructin using gld bullin. These studies advcate inclusin f 5% gld bullin in in a balanced investment prtfli. Oxfrd Ecnmics (2011) als mdel the expected behaviur f gld under a range f pssible future market cnditins and cnclude that gld bullin shuld perfrm well cmpared t ther assets in a deflatinary, inflatinary r a stagflatinary envirnment. Finally, we analysed the ratinale fr an Australian investr t hedge the A$/US$ currency risk fr their gld bullin investment, and cncluded that hedging the currency risk culd be a ratinal investment risk management tl. Surces Bernstein, Peter: The Pwer f Gld: The Histry f an Obsessin (Jhn Wiley and Sn, New Yrk, 2000) Bienkwski, Nik: A Glden Rule in Risk Management (JASSA, Issue 3, Spring 2002, 2-5) Knx, David: Gld Bullin and Superannuatin Investment Plicies: A review and analysis f the rle that gld bullin culd play in the investment plicy f Australian superannuatin funds (Pricewaterhuse Cpers Actuarial, Nvember 2002) Oxfrd Ecnmics: The Impact f Inflatin and Deflatin n the Case fr Gld (July 2011) BetaShares Gld ETF Trading Infrmatin BetaShares ETFs can be bught r sld thrughut the trading day n the ASX, and trade like rdinary shares. Exchange ASX Cde Currency Trading Blmberg IRESS CODE IRESS INAV Fund Infrmatin ASX QAU AUD 10:00-16:00 (AEST) QAU AU QAU.AXW QAUINAV.ETF Issuer BetaShares Capital Ltd underlying assets Physical Gld Bullin GOLD VENDOR Natinal Bank f Canada GOLD custdian JP Mrgan Chase Fund Administratr rbc Dexia Auditr PricewaterhuseCpers distributins* Annual Management Csts 0.49% p.a GOLD VENDOR/CUSTODY COSTS 0.10% p.a Fund Inceptin 3 May 2011 Abut BetaShares BetaShares is a specialist prvider f Exchange Traded Funds ( ETFs ) which are traded n the Australian Securities Exchange. Our bjective is t expand the universe f investment pssibilities fr investrs in Australia. We d this by prviding ETFs that track the perfrmance f a range f market indices and asset classes. Investing is as easy as buying any share. Australian-wned and managed, BetaShares is part f the Mirae Asset Glbal Investment Grup, ne f the largest asset managers in Asia, currently managing in excess f US$50B. T: (Australia) T: (ex Australia) inf@betashares.cm.au Imprtant: This infrmatin has been prepared by BetaShares Capital Ltd (ACN AFS Licence ), the prduct issuer, as at May It is general infrmatin nly and des nt take int accunt yur bjectives, financial situatin r needs s it may nt be apprpriate fr yu. Befre making an investment decisin regarding any BetaShares ETF yu shuld cnsider the relevant prduct disclsure statement ( PDS ) and yur circumstances and btain financial advice. The PDS is available at. An investment in any BetaShares ETF is subject t investment risk including pssible delays in repayment and lss f incme and principal invested. Past perfrmance is nt an indicatin f future perfrmance. Any pinins are subject t change withut ntice and actual events may differ materially frm thse reflected in any pinins r ther frward-lking statements. 9