World Gold Council: 4 reasons gold is a valuable portfolio component

The World Gold Council (WGC), the market development organization for the gold industry, has released its latest edition of Investment Commentary, which looks into relevant economic factors that may influence gold’s performance in the remainder of 2014. Their outlook for the yellow metal is mostly positive.

The report begins by stating that as of October 20, the gold price is up 3.4% this year with record low volatility, adding “The fact that gold has been above its 2013-end price for all but two days this year has defied predictions from market analysts, who have generally been expecting lower prices.”

The report goes on to analyze why current market conditions are supportive of long-term growth for gold, and concludes “there are four main reasons investors should view gold as a valuable portfolio component today.” Those reasons are the following:

1. Economic growth benefits gold demand

It is widely known that gold tends to be in high demand during times of economic and geopolitical crisis, as investors seek safe-haven assets. However, the report points out that gold demand can also benefit from times of positive economic growth.

In order to understand this, it is important to describe the three main sources of gold demand:

• Investment demand: Gold buying by investors, usually in the form of coins and bars
• Consumer demand: Gold buying by consumers, usually in the form of jewelry and electronics
• Central bank demand: Gold buying by central banks, usually in the form of bars and in large quantities

The majority of total gold demand comes from consumer demand. In the United States, it accounts for 50% of annual gold demand. During times of economic growth, incomes are higher and consumers can afford to buy more gold jewelry and electronics. WGC calculated in a previous report that with all else held equal, a 1% rise in global real GDP increased gold jewelry and electronic demand each by an average of 5%. And in countries such as India and China, the two largest gold consumers in the world, gold demand tends to closely correlate with increasing wealth. Therefore, gold demand does not only benefit when the economy is suffering – it can benefit from a growing economy as well.

2. Higher interest rates are not necessarily bad news for gold

The report questions the assumption that higher interest rates drive gold prices down. Popular opinion holds that as interest rates rise, so does the opportunity cost of holding gold, leading investors to move away from gold. However, WGC believes there are two problems with this assumption: 1) it leaves out consumer demand, and 2) it assumes U.S. interest rates reflect global interest rates. Consumer demand, which accounts for 58% of all gold demand, is not negatively affected by higher interest rates. WGC elaborates:

“This part of demand, as we explained before, is in fact pro-cyclical: it increases when GDP increases, a situation that generally coincides with rising interest rates. In addition, monetary tightening/easing cycles differ across regions. Even if the Fed were to lift interest rates – which we do not expect to happen anytime soon – other countries with a strong affinity to gold may maintain or even lower interest rates.”

For further reading on interest rates and gold, see our previous blog Gold and Interest Rates: What You Need to Know.

3. Gold is a cost-effective portfolio hedge

WGC compared multiple investment vehicles commonly used as portfolio hedges, and reached this conclusion: “Our research found a compelling case for gold as a valuable hedge. It is cost-effective, easy to obtain, and has a wide range of applications.” The report lists the following benefits of holding gold in a portfolio as a hedge against losses:

• Physical gold has no counter-party risk. You are the sole owner of it, as opposed to having a contract with a company that could go bankrupt.
• Gold has very high liquidity even when supply is limited, and is easy to obtain despite its scarcity.
• There is little to no active management required when owning gold. Since it is considered a long-term investment usually held for 5-10 years or more, there is less of a need to constantly monitor its performance.
• Cost of gold ownership is low. Aside from the initial purchase price, usually the only additional costs are storage fees. Other investments such as cars or real estate have a much higher cost of ownership, which includes insurance, maintenance, repairs, etc.

4. Supply constraints keep the gold market in balance

According to GFMS-Thomson Reuters, the estimated average cost of production for gold currently stands at $1,350/oz., and mine production is expected to start declining over the next few years. The gold price has been below $1,350 for some time now, meaning gold production is currently costing mining companies more money than they are taking in. Based on this data, the report concludes:

“While gold prices can fall below (all-in) production costs for various reasons, prices below this level are not sustainable for an extended period of time, in our view, unless mine production experiences a structural shift (such as a substantial and widespread reduction in costs of production or finding readily available new deposits, both of which we view as unlikely).”

These troubles in the gold mining industry are putting constraints on supply, which helps drive up demand and prices. In addition, gold recycling has been declining since 2009, further constraining supply.

Make gold a component in your retirement portfolio with a Gold IRA

If you agree with the reasons above and are convinced physical gold is a valuable component of any portfolio, consider adding it to your retirement account through a Gold IRA. The long-term protection, risk hedging, and cost-effectiveness of gold highlighted in this article make it particularly well-suited for securing your retirement assets and your financial future. For more information, call American Bullion today at 1-800-326-9598 to speak with a dedicated agent.