A golden ticket to investment returns Absa | Corporate and Investment Banking > Insights and Events > A golden ticket to investment returns Michael Mgwaba Head of Exchange-Traded ProductsAbsa CIB SHARE Including gold in a diversified investment portfolio can enhance risk-adjusted returns – especially in volatile markets. The investment banker JP Morgan said it best. ‘Gold is money,’ he told the United States Congress in 1912. ‘Everything else is credit.’ The World Gold Council estimates gold’s annualised return to be averaging at about 8.19% since 1971, when the US abandoned the gold standard. From an investment perspective, the precious metal cannot be ignored. So says Michael Mgwaba, Head of Exchange-Traded Products (ETPs) at Absa CIB. ‘Gold has performed very well over the past three years, with the price hitting new record highs and outperforming most major asset classes with an annual return of 29.03% on spot price,’ he says. ‘This price performance has been driven by resilient consumer demand, central bank diversification into gold (more noticeably over the past two years), Asian investment flows (exchange-traded funds (ETFs) and coins) and persistent geopolitical tensions.’ That growth comes despite a stronger US dollar and high-interest-rate environment – factors that have historically seen a decrease in the appeal of non-yielding financial assets. Factors driving the gold rush ‘Central bank buying spree continues to stand out as the biggest consistent contributor to gold’s price appreciation, with emerging markets playing a leading role,’ Mgwaba adds. ‘In its recent 2024 Central Bank Gold Reserves Survey, the World Gold Council found that advanced-economy central banks expected their share of gold in global reserves to rise at the expense of the US dollar, following the lead from emerging markets.’ That survey identified achieving effective diversification, hedging against inflation and hedging against systematic and political risks as common reasons for rebalancing in favour of gold. ‘These reasons do appear to justify central banks’ expected behaviour,’ says Mgwaba. ‘However, such a move could also potentially assist central banks to stabilise and boost their respective currencies’ values, which further strengthens the long-held view that “gold is money”.’ Asian investors are also driving the rush for gold investments. ‘Chinese investment markets are rewriting the rules of the game by developing price-exerting power through rapidly building up their capacity on gold investment through ETPs, and by participation in the futures market,’ Mgwaba explains. ‘On the investment side,’ he continues, ‘the Chinese Central Bank has embarked on a gold-buying spree to reduce its exposure to US debt, amongst other things. Volumes in futures markets and commodities exchanges have doubled in 2024, while gold exchange-traded funds have been experiencing 15 months of net inflows. This contrasts with US- and European-region ETFs, which have experienced record outflows, though we now seeing these market reversing to net inflows. While there are several reasons for Chinese investors shifting their focus to gold, one could also argue that some local investors may have been influenced by their central bank’s buying activities and unsatisfactory performance of its real estate market.’ The investment case for gold There are persuasive arguments both for and against including gold as an asset in a diversified investment portfolio, and many studies that provide insights into the issue. ‘Most of these studies are based on developed or advanced markets,’ Mgwaba warns. He points to analysis that uses a hypothetical diversified investment portfolio based on South African capital markets. ‘This exercise looks at the role of gold at various levels of allocations, but for the same period,’ he explains. ‘It’s slightly different from the World Gold Council analysis, which focuses on the same level of gold allocation (5%) but at different time horizons. In our analysis, we used NewGold as representing physical gold.’ The hypothetical multi-asset portfolio starts with a zero allocation to gold. The building blocks of the portfolio include cash (STeFI 3-month Index), South African equities (FTSE/JSE All Share Index TR Value), international equities (MSCI All Country World Index TR Gross), properties (FTSE/JSE SA Listed Properties TR Index), South African bonds (FTSE/JSE ALBI TR Index), international bonds (Bloomberg Global Aggregate Bonds TR Index) and alternative assets (NewGold). ‘We then added incremental allocations of 2.5%, 5%, 7.5% and 10% to NewGold (NGLD) in our hypothetical portfolio,’ says Mgwaba. ‘Our data points covered periods from 4 November 2004 to 31 December 2023.’ The portfolio outcomes are shown in this table: Portfolio Name NGLD Allocation (%) Annualised Returns (%) Annualised Standard Deviation (%) Sharpe Ratio* (%) Maximum Drawdown (%) Portfolio 1 0 12.93 9.47 1.36 23.06 Portfolio 2 2.5 13.03 9.25 1.41 21.59 Portfolio 3 5 13.12 9.05 1.45 20.11 Portfolio 4 7.5 13.21 8.89 1.49 18.60 Portfolio 5 10 13.30 8.75 1.52 17.08 Source: Absa, Bloomberg * The Sharpe Tatio compares the return of an investment to its risk. ‘In our hypothetical scenarios, Portfolios 2, 3, 4 and 5 had higher Sharpe ratios, lower maximum drawdowns and lower standard deviations, with higher returns compared to Portfolio 1, the portfolio with no exposure to NewGold,’ says Mgwaba. ‘From a risk-adjusted return perspective, our hypothetical blended portfolio results showed that adding a 2.5%, 5%,7.5% or 10% allocation to NewGold in the portfolio would have improved Sharpe ratios. From a risk management perspective, hypothetical portfolios with NewGold allocation had lower maximum drawdowns.’ Ongoing market volatility makes risk management strategies like diversification more important than ever, he says. ‘Based on our analysis, adding gold enhances the risk-adjusted return for a South African multi-asset portfolio. There is merit in looking to gold as a diversifier. However, optimal allocation varies depending on the examined period. There are several ways to gain exposure into gold, and this analysis only examines the exposure produced by gold bullion and gold ETFs.’ Either way, ‘Investors can no longer easily ignore the role of gold in portfolio construction,’ he concludes. Michael MgwabaHead of Exchange-Traded Products Absa CIB https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles RISK MANAGEMENT FX Hedging in the Age of Big Data and AI Digital technologies like AI and machine learning highlight why corporate treasurers need a data-enabled FX provider. Read more RISK MANAGEMENT Why Africa’s Approach to Financial Risk Management Needs to Change When detached from the intricate realities of Africa’s economic environment, financial risk management strategies that may prove successful elsewhere often falter. Read more EVENTS Macro and Risk Management Conference 2024 The Macro and Risk Management Conference showcases Absa’s ability to help clients understand the world around them by bringing together global experts and utilising our thought leadership capabilities. The conference also encourages our clients to shift from day-to-day information flow and focus on the bigger strategic picture. Read more
