Finance Assignment: URGENT
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GoldCaseStudy-GOLDASAPORTFOLIODIVERSIFIERTHEWORLDGOLDCOUNCILANDINVESTINGINGOLD.pdf
UV6524 Rev. Sept. 26, 2012
This case was written by Assistant Professor Richard B. Evans and Associate Professor Pedro Matos. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2012 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means— electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. The materials have been prepared only for educational purposes and not for any other purpose, including as an offer to sell or the solicitation of an offer to buy any securities. By using these materials, you agree that you will not display, reproduce, store in a retrieval system, or transmit these materials to any person for any use other than educational purposes.
GOLD AS A PORTFOLIO DIVERSIFIER: THE WORLD GOLD COUNCIL AND INVESTING IN GOLD
There was an audible buzz in the room as Juan Carlos Artigas, global head of investment research at the World Gold Council (WGC), finished speaking. “The Strategic Case for Gold as an Asset Class,” his presentation at the 2012 Bloomberg Precious Metals Conference in New York, had attracted quite an audience. As a result of the market collapse in 2008 and the ongoing euro-area crisis, investors worldwide had safety and security on their minds, and many in the room were wondering whether gold would provide capital preservation and improve the overall risk-return tradeoff of their portfolios. At the same time, the sustained run-up in the price of gold since 2001 that Artigas had talked about in his presentation was a cause for concern. Was gold the safe haven that it had proved to be in 2008 and 2009, or was it an asset class at the peak of a bubble? The investment case for gold deserved closer examination. The World Gold Council
Founded in 1987, the WGC is a market development organization that represents the world’s largest gold mining companies. While many institutional investors were aware of the WGC, it had obtained even wider visibility in recent years due to the 2004 launch of an exchange-traded fund (ETF) that tracked the price of gold.
The SPDR Gold Shares ETF (GLD) was sponsored by the WGC and had launched in November 2004 in coordination with State Street Global Advisors (SSgA). SSgA was a pioneer in the ETF market, having introduced the S&P Depository Receipts Trust Series (SPDR), pronounced “spider,” a decade earlier. GLD was the first U.S.-listed gold ETF to be backed by the physical asset, and it was one of the fastest-growing ETFs in history, reaching close to 1,300 metric tons of gold under custody, making assets under management in the trust valued at over $70.3 billion at the end of February 2012. GLD was the most successful commodity-based ETF to date. While the focus of the WGC before 2004 was primarily on the use of gold in jewelry, the
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launch of the ETF signaled a strategic shift to increase the visibility of gold as an investable asset. The presentation at the Bloomberg industry conference was one element of the WGC’s strategy to introduce gold to a broader group of investors. The Strategic Case for Gold as an Asset Class
Exhibit 1 provides selected slides from the WGC presentation, which can also be watched online.1 Gold had a significant “bull run” in the previous decade, reaching a price of over $1,530 per ounce at the end of 2011, and it had averaged an investment return of 17.4% per year since 2001 (slide 1). In stark contrast, during the same period, the S&P 500 earned a meager 3% return. But the argument for gold was not just one of excess returns relative to other investments because gold had the potential to be an important source of risk reduction and capital preservation (slide 2). Gold returns tended to be positive in periods of financial turmoil and offered portfolio-diversification benefits. The correlation between the returns of gold and the returns of other asset classes was very low (slide 3), and the volatility of the return on gold (slide 4) was lower than that of U.S. or emerging-market equities and real estate (as represented by REITs) or commodities, two additional “real assets” that many investors would consider the closest alternatives to gold. Also with the prospect of significant inflation looming in the future, the high real investment return on gold in inflationary periods (slide 6) could preserve the purchasing power of investor capital.
Although the risk and return calculations in the WGC presentation characterized gold’s overall behavior, as an investment, it exhibited unique properties in bear markets that made it particularly attractive to investors seeking security. The distribution of returns for many asset classes exhibited negative skewness, whereas the returns on gold were positively skewed (slide 5). Put another way, this means that while the returns on gold that investors earned in a bull market had volatility similar to that of equities, for example, in a bear market when investors desired safety most, the returns on gold were less volatile. This combination of very low correlation with other asset classes and positive skewness could potentially protect investors against market crashes, which were often called “tail events.” During seven of the worst market events since 1987 (slide 7), even a small gold allocation of 5% would have reduced investor losses substantially. Overall, even a small allocation to gold would have helped improve risk- adjusted returns (slide 9).
The WGC admitted that global investment allocations to gold remained small (slide 15), but it argued that the liquidity and aggregate dollar size of the gold market was comparable or superior to other investment asset classes (slide 8). Using the stock of gold for private investment, WGC valued the financial market for gold at $3.4 trillion, making it bigger than all sovereign debt markets except for U.S. treasuries and Japanese government bonds. Additionally, the London Bullion Market Association estimated that the over-the-counter market for gold
1 Presentation is available at http://www.youtube.com/watch?v=THE8eBX3uk4.
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traded, on average, $240 billion a day with 90% of these transactions based on physical (not synthetic) contracts,2 and the advent of the GLD ETF in 2004 made investment in gold more accessible to a wider spectrum of investors.
In recent years, prominent hedge-fund managers such as John Paulson (who held over 4% of all GLD shares) and the Soros Fund had invested in gold as a store of value to protect its capital as record-low interest rates eroded returns on currencies. Even some pension funds, which were typically slower to diversify into new asset classes, had allocated portions of their portfolios to gold. Public plans such as Texas Teachers and private ones such as the Lockheed Martin Investment Management Co. had invested in gold through the purchase of GLD shares. Other large endowments had invested directly in gold. The University of Texas Investment Management Co. had converted its investments in gold producers and other gold-related securities into bullion in spring 2011. The company took physical delivery of the gold bars, worth approximately $1 billion, and stored them in a bank vault in New York. The WGC believed that as it spread the word about the benefits of investing in gold, other investors would follow suit. The Decision
After the floor at the Bloomberg conference was opened for questions, there were a number of issues raised that were clearly of interest to investors. Was gold a bubble asset? While Artigas had argued in his presentation that gold’s recent price appreciation did not resemble previous bubbles (slides 10 and 14) and that diversified and growing demand for gold (slides 11 and 12) combined with limited supply (slide 13) suggested stable if not increasing gold prices in the years ahead, opinions were divided. Some analysts questioned whether gold was losing its luster as an asset of last resort and that the investment case for gold relied on the high historical average returns it had experienced. While gold had an average annual return of 19% over the previous 10 years (2002 to 2011), its average investment return for the last 25 years (1987 to 2011) was less than 6%. If investors expected lower returns for gold going forward, would it still make sense to invest in gold?
Other questions were raised. Why should investors invest in gold if it did not provide income as did dividend-paying equities or commodities with commercial utility (e.g., oil or corn)? A participant pointed to a recent quote from the legendary investor Warren Buffett who said, “If you own one ounce of gold for an eternity, you will still own one ounce at its end.” 3 Given the costs associated with owning gold (e.g., physical storage, insurance, and transaction costs), the income stream from a gold investment could actually be negative. Should these costs affect the decision of whether or not to invest?
2 London Bullion Market Association, LBMA Gold Turnover Survey for Q1 2011, Alchemist 64 (August 2011). 3 Warren Buffett, “Why Stocks Beat Gold and Bonds,” Fortune, February 27, 2012.
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The most common question from the audience, however, had been about how much of an investor’s portfolio should be allocated to gold? Many retail investors used a mix of equities and bonds as core assets in their portfolios. Exhibit 2 provides annual returns for these major asset classes and gold from 1988 to 2011. The more sophisticated institutional investors of pension funds and endowments might consider gold as an alternative to other “real” asset classes such as commodities and real estate that also protected against inflation. Exhibit 3 provides historical means, standard deviations, and correlations computed from monthly return data (6/30/1992 to 6/30/2012) for 11 asset classes more commonly employed by sophisticated investors when structuring their portfolios, including these real assets. But even given all of this data, the question remained, what fraction, if any, of an investor’s portfolio should be invested in gold?
For the exclusive use of C. Tu, 2017.
This document is authorized for use only by Chenchen Tu in Advanced Portfolio Management Fall 17 taught by Joseph Colantuoni, Johns Hopkins University from August 2017 to February 2018.
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Exhibit 2 GOLD AS A PORTFOLIO DIVERSIFIER:
THE WORLD GOLD COUNCIL AND INVESTING IN GOLD Annual Return Data, 1988 to 2011
Data sources: The U.S. large cap equities returns are calculated from the St Louis Fed’s S&P 500 Index return series (http://research.stlouisfed.org/fred2/series/SP500?cid=32255). The U.S. bond return series is calculated from the annual returns with dividend reinvestment on the Vanguard Total Bond Market index funds gross of expenses. The U.S. T-bills return series is calculated from one month of T-bill returns from Ken French’s website (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html). The gold return series is calculated from gold price data (U.S. dollars per troy ounce, source: LBMA taken from the WGC website http://www.gold.org/investment/statistics/gold_price_chart/).
Date U.S. Large Cap
U.S. Bonds U.S. T-Bills
Gold
1988 15.72% 7.68% 6.36% -15.26% 1989 10.63% 13.92% 8.38% -2.84% 1990 4.51% 8.88% 7.84% -3.11% 1991 18.86% 15.43% 5.60% -8.56% 1992 7.34% 7.36% 3.50% -5.73% 1993 9.76% 9.88% 2.90% 17.68% 1994 -2.32% -2.48% 3.91% -2.17% 1995 35.20% 18.42% 5.60% 0.98% 1996 23.61% 3.79% 5.20% -4.59% 1997 24.69% 9.66% 5.25% -21.41% 1998 30.54% 8.80% 4.85% -0.83% 1999 8.97% -0.56% 4.69% 0.85% 2000 -2.04% 11.64% 5.88% -5.44% 2001 -17.26% 8.67% 3.86% 0.75% 2002 -24.29% 8.50% 1.63% 25.57% 2003 32.19% 4.20% 1.02% 19.89% 2004 4.43% 4.45% 1.19% 4.65% 2005 8.36% 2.60% 2.98% 17.77% 2006 12.36% 4.48% 4.81% 23.20% 2007 -4.15% 7.12% 4.67% 31.92% 2008 -40.09% 5.26% 1.68% 4.32% 2009 30.03% 6.17% 0.09% 25.04% 2010 19.76% 6.65% 0.09% 29.24% 2011 2.04% 7.79% 0.04% 8.93%
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Exhibit 3
GOLD AS A PORTFOLIO DIVERSIFIER: THE WORLD GOLD COUNCIL AND INVESTING IN GOLD
Asset Class Return Statistics for 11 Asset Class Portfolios
Panel A: Averages and Standard Deviations (monthly return data, 6/30/1992–6/30/2012)
Panel B: Correlations (monthly return data, 6/30/1992–6/30/2012)
Panel C: Baseline Optimized Portfolio
Note: Calculations by authors based on monthly returns from 6/30/1992–6/30/2012. Data sources: Ken French’s website (U.S. T-bills); Barclays Capital US Aggregate (U.S. bonds); Barclays Capital Global TSY AGG ex US (global bonds); Russell 2000 TR (U.S. small cap); MSCI US TR (U.S. large cap); MSCI EAFE TR (developed market equities); MSCI EM TR (emerging market equities); HFRI fund-weighted composite (hedge funds) DJ US Select REIT TR (U.S. REITs); S&P GSCI TR (commodities); and London PM Fix (gold). All series are total return except hedge fund index and gold.
Altern.
U.S. T-Bills
U.S. Bonds
Global Bonds
U.S. Small Cap
U.S. Large Cap
Developed Market Equities
Emerging Market Equities
Hedge Funds
(HFRI) U.S. REITs
Commodities (GSCI)
Gold (dollars/oz.)
Avg. 3.78% 6.29% 6.38% 10.44% 9.12% 7.16% 11.00% 9.93% 13.07% 5.50% 8.80% Std. Dev. 0.64% 3.69% 8.14% 19.66% 15.24% 17.11% 24.11% 7.12% 20.97% 21.69% 15.97%
Fixed Income Equities Real Assets
U.S. T-Bills
U.S. Bonds
Global Bonds
U.S. Small Cap
U.S. Large Cap
Developed Market Equities
Emerging Market Equities
Hedge Funds
(HFRI) U.S. REITs
Commodities (GSCI)
Gold (dollars/oz.)
U.S. T-Bills 1.00 0.16 0.02 -0.06 0.02 -0.04 -0.09 0.09 -0.11 -0.05 -0.12 U.S. Bonds 0.16 1.00 0.46 -0.04 0.05 0.03 -0.02 0.03 0.13 0.02 0.16 Global Bonds 0.02 0.46 1.00 0.07 0.10 0.34 0.13 0.08 0.21 0.20 0.35 U.S. Small Cap -0.06 -0.04 0.07 1.00 0.80 0.72 0.72 0.82 0.63 0.30 0.09 U.S. Large Cap 0.02 0.05 0.10 0.80 1.00 0.79 0.73 0.74 0.54 0.25 0.00 Developed Market Equities -0.04 0.03 0.34 0.72 0.79 1.00 0.77 0.74 0.53 0.37 0.16 Emerging Market Equities -0.09 -0.02 0.13 0.72 0.73 0.77 1.00 0.82 0.46 0.34 0.22 Hedge Funds (HFRI) 0.09 0.03 0.08 0.82 0.74 0.74 0.82 1.00 0.42 0.39 0.18 U.S. REITs -0.11 0.13 0.21 0.63 0.54 0.53 0.46 0.42 1.00 0.22 0.09 Commodities (GSCI) -0.05 0.02 0.20 0.30 0.25 0.37 0.34 0.39 0.22 1.00 0.25 Gold (dollars/oz.) -0.12 0.16 0.35 0.09 0.00 0.16 0.22 0.18 0.09 0.25 1.00
Portfolio weight U.S. T-Bills 1.20% U.S. Bonds 19.40% Global Bonds 11.30% U.S. Small Cap 14.30% U.S. Large Cap 12.60% Developed-Market Equities 1.60% Emerging-Market Equities 13.00%
Alternatives Hedge Funds (HFRI) 13.70% U.S. REITs Commodities (GSCI) Gold (dollars/oz.)
Fixed Income
Equities
Real Assets 12.90%
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