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Why valuation uncertainty takes shine off gold


Precious little pricing: why valuation uncertainty takes shine off gold

Gold remains a problematic asset class for investors despite a glittering performance in recent times, according to a new paper by Auckland consultancy firm, Makao Investments. The Makao analysis says gold has increasingly popped up in investment strategy discussions of late following a “stellar run” in the precious metal that saw its price rise about 50 per cent since March this year.

But despite offering some apparent long-term protection against inflation, the paper warns “it is impossible to determine the fair value of gold at a particular point in time”. The report says: “As such, investors cannot be sure whether investing in gold now means that they are buying at a time of opportunity, as was the case 20 years ago – or at a peak in gold prices, like we saw 40 years ago… Therefore, we believe investors should also consider other real assets – especially assets that can be valued properly – as an alternative for an inflation-hedge in their portfolio.”

Over the last two decades gold has been a decent bet, the study shows, returning an annualised 11.2 per cent compared to 6.2 per cent for inflation-linked bonds and 7.2 per cent for global equities. However, gold’s reputation as a defensive asset is dented by an annual volatility measure of almost 17 per cent over the last 20 years – more than double inflation-linked bonds (7.5 per cent) and higher than global shares (15.2 per cent).

  • “Regardless of the volatility, gold’s performance over the last 20 years has been impressive, and it has outpaced inflation by almost 10% p.a,” the paper says. “However, we have to be mindful of recency bias. We have doubts that it is sustainable for gold to outperform inflation by such large margins over the long-term, and therefore caution investors from allocating significant parts of their portfolio solely to the metal. Gold investors had, for example, no returns or even losses between the early 1980s and the mid-2000s.”

    For the 40 years to the end of July this year gold returned just 3.1 per cent per annum with a still-high annual volatility of 16.2 per cent: by contrast, international equities recorded annualised performance of almost 10 per cent while experiencing 14.9 per cent yearly price swings.

    NZ investors also must consider how currency affects gold pricing, given the asset is priced in US dollars.

    “In fact, the impressive 20-year return noted above drops by 2.8% (11.2% to 8.4%), and volatility increases further without currency hedging,” the Makao report says.

    Gold has hovered around the US$2,000 mark over the last few weeks, up from a low of under US$1,500 in March this year. A number of institutional investors, including State Street Global Advisors (SSGA), have been building gold allocations.

    A recent SSGA report, for instance, notes: “Investors should build tactical hedges – we currently favor gold – and consider additional approaches to help manage their overall risk exposure, including low-volatility and defensive equities.”

    As the manager of the world’s largest gold exchange-traded fund (ETF), SSGA has also benefited from further retail flows into the asset class. George Milling-Stanley, chief gold strategist, told Bloomberg this August that: “At these times, [gold is] a very good business to be in. There’s no question in my mind that ETF demand is driving gold right now.”

    But while pricing gold is a fool’s game, Makao notes inflation fears could be stoking the current bull market.

    “The best we can arguably do is to look at real yields as an indicator, and on that basis, gold seems to look rather expensive, or, as some would argue, simply priced for a severe, sharp shock in inflation,” the report says.”… Without any reliable way to value gold, the best we can do is to wait and see whether this time it is different.”

    Founded in 2019 by former Russell Investments NZ head of institutional, Noah Schiltknecht, Makao has since landed several consulting gigs. John Horrell, another Russell alumni, moved back from the UK to join Makao as partner shortly after the business launched.

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