Despite Australia’s strong relationship with gold, the typical Australian investor’s allocation to gold is extremely low compared with European and US equivalents. There are a few reasons why this may be the case, which I’ll explore shortly. However, the reality is that there are good arguments to suggest that every investor should consider at least a small allocation to gold within their portfolio and using an Exchange Traded Fund (ETF) to achieve that allocation is one of the simplest and most cost efficient ways to achieve this.
Economic Perspective
Around the developed world base rates are converging on zero with a few key economies actually offering negative rates. Australia’s benchmark is not yet zero, but is moving slowly towards it. The reasons why this is the case are well known – basically an attempt by central banks to stimulate economies by encouraging borrowing to invest and to discourage saving.
On the whole this strategy has either worked or is beginning to. However, when you reinvigorate your economy through ultra-low rates there is a significant risk of inflation. Inflation is good if it remains within a reasonable 2-3% range. Goods and services cost a little bit more each year but salaries should go up to match so all is in balance. This is a central bank’s perfect world.
However, if you get the level of stimulation wrong, you can build too much inflation into the system and this causes many problems but the primary one is that your money begins to erode in value, often quickly. We haven’t reached that point yet, and we may not, but it is a considerable risk made likely by the consistent prolonged activities of the central banks.
In the chart below you can see that Consumer Price Inflation (CPI) and Core CPI are both picking up. Core CPI is a key indicator for central banks as it doesn’t include energy and food and the upward momentum is clear.
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Why Gold?
Within such an environment investors should be considering how to protect the value of their portfolio and gold has historically been an important exposure to help in that.
In the chart below it’s clear to see the close relationship between the gold price and real interest rates. When real interest rates are negative, as they were in the US in 2011 and are now, the gold price rallies as investors buy it as a store of monetary value. If inflation starts to kick in and real interest rates decline further, you can expect gold to continue to rally.
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Event Hedge
Apart from inflation protection, gold should also be included in portfolios for its ability to protect in catastrophic situations. As in the table below, you never know when they will occur but gold nearly always performs well in such situations
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Gold Access
So how do Australian investors access gold?
There are three main methods to get access to gold
- Gold mining stocks
- Physical gold
- Physical gold ETFs
Many consider gold miners to be a good proxy for gold but, in reality, the relationship is not that clear. Miners suffer from equity risk. In other words they are companies and can be affected by all the standard corporate vagaries both positive and negative and this is illustrated below.
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Buying physical bullion gives you direct access to actual bullion. This has become easier and cheaper as time goes on and bullion manufacturers have made access more economic. However there is normally a premium charged above the spot rate of gold that can make it more expensive than other methods of ownership.
Investing in ETFs to get gold exposure has become increasingly popular. Tracking almost exactly the price of gold an investor is able to buy and sell gold with very low transaction costs in the same way as they buy an Australian share. The safest gold ETFs are ones which are “fully allocated”. In other words your ETFs have direct title on the bullion stored in the vault on your behalf.
ANZ ETFS Physical Gold ETF (ZGOL) is a good example of such a product. It is up 22.42% over the year to date, has an annual fund fee of 0.4% and it trades on the ASX with a bid/offer spread of approximately 0.1% – 0.15%. So, as an investor, you have a manager providing safe custody for your gold in a highly secured vault in Singapore for less than it would cost to buy the gold directly (in most cases) and without any company risk. This gives you some of the portfolio protection you need in a world where inflation may be creeping in and where catastrophic events often occur.
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