Gold’s role as an indispensable asset for diversifying and de-risking an investment portfolio in the face of economic uncertainty is well established. Yet, according to an analysis by the World Gold Council, it can provide a higher long-term return than is generally assumed.

Although it is generally perceived as a conservative option to reduce investment risk and its primary function is as a store of value, a report by the World Gold Council (WGC) concludes that traditional analyses of gold’s returns miss some important factors that reveal a better long-term return than is often thought.

According to the WGC, frameworks exist for estimating long-term gold returns, but they lack a robust approach that conforms to capital market assumptions for other asset classes. These estimates are closely correlated with the general price level as measured by the consumer price index (CPI). According to this assumption, the expected long-term return on gold is typically in the range of 0% to 1%.

However, the agency’s analysis concludes that, while existing studies are rich in information, they are often based on two patterns that, in its view, “mischaracterise gold and have led to biased conclusions”.

The Gold Standard and financial investment

To begin with, almost all models use data from gold standard periods. Although the World Gold Council accepts that as a general rule it is better to have as much historical data as possible when analysing gold prices, the longer chronology skews the data because, for most of the 20th century, the price of gold was set by central banks.

“While its historical performance during the Gold Standard periods is an interesting benchmark, what is more important is its market structure and behaviour after 1971”. Therefore, in order to avoid this bias, the agency uses data from 1971 onwards to do its analysis.

The other factor that can make the analysis of gold’s long-term behaviour unreliable is that models often assume that financial investment almost exclusively drives demand, ignoring other important demand factors. According to the study, financial investment accounts for a relatively small percentage of demand relative to existing gold reserves, while other sources are more important in the long run.

In conclusion, using this revised model proposed by the World Gold Council, the returns of gold has been much better over the last 50 years than conventional analysis suggests, with an annual average of 8%. The same model forecasts an average annual return of 5.2% over the next 15 years.

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