Gold Behaves More as a Currency Than a Commodity

Gold Behaves More as a Currency Than a Commodity


Gold is often included into commodities, as gold is a metal. And just like other raw materials, it is used in the production of manufactured goods. But gold is much more than that. According to the recent report published by World Gold Council (WGC) there are 6 features which differentiate gold from other commodities, they are as follows:

  • Gold has delivered better long-term, risk-adjusted returns than other commodities;
  • Gold is a more effective diversifier than other commodities
  • Gold outperforms commodities in low inflation periods
  • Gold has lower volatility
  • Gold is a proven store of value
  • Gold is highly liquid.

Gold has indeed outperformed not only broad-based indices but also sub-indices and most individual commodities over the last several years. In particular, as the chart below shows, the general commodity index has fallen since 2014, while gold prices have risen during that period.

Chart 1: Gold prices (yellow line, right axis, London P.M. Fix, $) and IMF’s Global Price Index for all commodities (red line, left axis, 2016 = 100) from January 1992 to September 2019.

Gold is also a better portfolio diversifier. This is because gold is negatively correlated with other assets during economic crises, hedging investors from tail risks. In contrast, industrial commodities are positively correlated to economic growth.

The precious Yellow metal is less volatile that other commodities. One thing is that the gold market is very liquid. The average daily trading in the global gold market ranges between $100-B and 200-B a day. And, what is also important is that there are enormous gold holdings around the world.

In other words, gold in contrast to Crude Oil and other commodities has very high ratio of stocks to flows. It means that changes in the annual mine production or in technological demand have a tiny impact on the gold market.

The WGC claims that gold is a better hedge against inflation. Although all commodities protect against high inflation, gold is said to perform better during periods of low inflation. Although it’s true that gold has outperformed many commodities in recent few years of subdued inflation, the 1980’s and 1990’s showed that the precious Yellow metal can struggle in periods of muted price pressure.

Gold is a store of value, and gold should not be treated as commodity, but as monetary asset. This is because newly mined gold is not consumed but accumulated.

So, the annual balance of supply and demand is irrelevant for gold prices. It makes gold behave much more as a currency than as a commodity.

The investing implication is that gold should be differentiated from other commodities. Investors put gold into the commodities sector, although it behaves differently and better in many respects.

It means that gold is very often underrepresented in investment portfolios, as the commodity indices have a very small allocation to gold, typically between 3 and 12%. As commodities tend to represent a small portion of investors’ overall portfolio, say 10% gold’s weight is very small.

Gold has unique features and to substantially improve the performance of an investment portfolio its share should be higher and, according to many experts, somewhere between 5 to 10%.

Have a terrific weekend.

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