Features, benefits and risks of investing in the metal via an ETF.

The price of gold has rallied by almost 15 per cent in Australian dollars in the first few weeks of 2020 as rising tensions between the United States and Iran, and fears over the spread of the coronavirus, propelled the price above A$2,450 per troy ounce.

The rally continues a strong run for gold that dates back to the final quarter of 2018, when a correction in equity markets reignited safe haven demand for the precious metal. Over the 16 months to the end of January 2020 gold has risen by more than 40 per cent in A$ terms, strongly outperforming the local equity market.

This outperformance can be attributed to many factors, including the rise in the value of negative-yielding debt and a return to monetary easing by central banks around the world. This includes the Reserve Bank of Australia, which cut interest rates to a record low of 0.75 per cent in 2019.

Demand for gold has also risen, best seen through the 50-year highs in central bank gold buying, with total purchases from this sector topping 650 tonnes in both 2018 and 2019.

Exchange-traded fund (ETF) holdings have also increased, with the total tonnes of gold held across global gold ETFs rising by 16 per cent in 2019.

Demand was particularly strong in Australia in 2019; total holdings, including those in Perth Mint Gold (ASX: PMGOLD), increased by more than 45 per cent for the year.

Holdings in PMGOLD have continued to grow by a further 10 per cent in the first few weeks of 2020, highlighting that demand remains strong in the current environment.

Are gold ETFs the way forward?

Although the majority of investment demand for gold still comes in bar and coin form, gold ETFs have become an increasingly important part of the market. These products are designed to track the spot price of gold, with the ETF product issuer typically storing gold on behalf of investors in the ETF.

Gold ETFs offer many advantages to investors, not least the ease of buying and selling them alongside shares and other listed products on ASX.

Also, gold ETFs are often a more cost-effective way of getting exposure to gold, with trading and storage costs typically lower than buying and storing bars or coins directly.

Gold ETFs allow investors to trade in smaller parcel sizes than one troy ounce. For example, Perth Mint Gold was trading at just over A$24 per unit on 20 February 2020, tracking the spot price, which on the same day traded above A$2,400 per troy ounce.

The major drawback for gold ETFs is that they only trade while the ASX is open, whereas the gold market itself trades 24/7. This is one reason some investors prefer to trade with an organisation like The Perth Mint directly, while others like the tangibility of holding their own physical bars and coins and are willing to pay a premium for this.

It is also important for investors to consider where the gold backing the ETF is stored and the reputation of the custodian.  

Notwithstanding the above, gold ETFs are a great option for most investors, especially those that see gold as a long-term investment and who would rather not worry about having to store the gold themselves.

Case for gold in an investment portfolio

Although gold does not pay an income and can be volatile (like the equity market) in the short term, it has multiple attributes that support its role in a portfolio. These include the fact gold has generated strong long-term returns, increasing by more than 9 per cent per annum since the start of the 1970s.

Gold has also been an excellent hedge against volatility in equity markets. Research by The Perth Mint shows that no asset has outperformed gold in periods of equity market weakness, helping to bring balance to a portfolio.

In today’s environment there is one other factor that is arguably most important when it comes to gold’s role in an investment portfolio: gold’s historical outperformance in low real interest rate environments.

The Perth Mint analysed market data between 1971 and 2019 and found that gold historically increased by an average of just over 20 per cent per annum in years that real interest rates were below 2 per cent.

This is a market-leading return, with gold typically outperforming equities and bonds in those years, as the following chart makes clear.

Source:  The Perth Mint, SMSF Whitepaper 2020. Data based on historical analysis from 1971 to 2019 inclusive.

Although there are no guarantees interest rates will stay low for years to come, it is something investors should prepare for. RBA governor Phillip Lowe said in February: “It's quite likely we are going to be in this world of low interest rates for years, perhaps decades, because it is driven by structural factors in the global economy.”

Expectations of low rates for another decade or more are also reinforced by long-term government bond yields, with Australian 10-year and 15-year government bonds both yielding less than 1.50 per cent (below inflation) in February 2020.

This monetary tailwind, combined with expensive equity markets, an uncertain global economic picture and ongoing geopolitical tension, should see demand for gold, and therefore gold prices, supported in the years to come.