A s economists and financial analysts ponder the momentum and durability of the economic recovery, their considerations are overshadowed by persistent uncertainty and a fundamental lack of confidence in financial markets and investment strategies among investors and the wider public. Gold can play a crucial part in rebuilding confidence in savings and investments, and in strategies aimed at safeguarding wealth and securing future prosperity.

We are currently standing at a crossroads and, while hopefully heading in the direction of recovery, the path ahead is distinctly unclear. Whichever way we turn, the chances are that we are facing a very rocky road ahead. We have, over the last few years, endured unprecedented turmoil in financial markets and are still extremely uncertain as to the consequences and final cost of the escape routes and exit plans. The solvency of several nations remains in question and the threat of a contagious spread still overhangs many developed countries and markets. And the continuing trickle of damning news regarding the behaviour and operations of financial corporations only exacerbates these anxieties. The negative effects of this insecurity pervade all sections of society, and the investment community in particular is struggling to come to terms with the fact that recent events have eroded not only wealth but also confidence.

While investment strategists and asset managers may now have their eyes firmly fixed on recovery, they will need to widen their horizons beyond the pursuit of immediate return opportunities and focus on broader and longer term objectives if they are to help safeguard wealth and prosperity. They also need to clearly demonstrate that they have learnt from recent history and past mistakes.

Wealth managers and advisors must now prove to their clients and potential investors that their strategies stretch well beyond the prevailing cycle. This is particularly vital when we consider that, at least in the developed world, economic growth can no longer be taken for granted and market conditions alone are unlikely to provide solutions to the current malaise. A socio-cultural shift in the West away from wealth preservation, increasingly short-term investment horizons and well-publicised poor performance records mean investment professionals now face a generation that may no longer recognise their value or trust their efficacy.

In Lombard Odier’s recent private banking investment strategy quarterly¹ they warn of the dangers of responding to the profoundly disappointing performance of most strategies over the last decade by discarding long hold investing in favour of a shorter term ‘activist’ and allegedly more ‘nimble’ approach. The report points out that the perception that the years leading up to the credit crisis had been dominated by long hold strategies is actually a myth:

‘…despite overwhelmingly compelling evidence that it pays to “play the long game”, the average holding period for an individual stock on the New York Stock Exchange currently sits at an unbelievable six months (versus eight years in the mid 1950s) and has been trending steadily lower for 50 years.’

Lombard Odier’s strategists suggest that, rather than abandon longer term strategic investments, investors should avoid focusing on short term forecasts and the pursuit of short term returns, which they describe as ‘transitory’, and instead acknowledge the ‘extraordinarily compelling evidence’ that stable, predictable returns can only be achieved by adopting longer term strategies.

The corrosive dangers of over-active fund management are also highlighted in a recent survey² suggesting that many fund managers have far shorter investment horizons than they intend or declare, even though they may be well aware that such tendencies can have destructive and costly implications.

Regardless of the growing volume of calls for shorter-term ‘activism’, most asset managers, even those of a more tactical nature, would probably agree that the key to robust portfolio management is to maintain the risk-return balance of the portfolio in line with overall strategic objectives and these objectives should represent the lion’s share of overall investment. Unfortunately, far fewer would agree how to translate this principle into practice. Progress is also inhibited by the fact that many investors – and many investment professionals – still struggle to acknowledge or comprehend the fact that asset allocation policy, rather than fund and fund manager selection, is the primary factor in determining portfolios returns over time, even though it is fairly well proven by a range of research.

To restore broader faith and achieve better balance in investment strategies might require a fundamental shift in perspective on the part of many asset managers, but it does not necessarily imply a major and costly disruption to current investment planning and procedures. Relatively small changes can have a significant impact.

The search for assets that can be relied upon to protect wealth and stabilise investment strategies has, over the last decade, been increasingly driving investors back to one of the oldest assets known to man, but one that can also now be proven to offer unique benefits in the context of contemporary investment strategies, and that is gold.

While gold’s role as a safe haven and protector of wealth in uncertain times has certainly helped support its recent sequence of record-breaking price highs, it is worth noting that its value was on the rise well before the first dark cloud was spotted on the economic horizon. In a number of recent reviews of asset performance over the last decade gold has been identified as the stellar performer. The annual average price has risen for eight consecutive years and, at the time of writing, the price (the London pm fix) is around 190 per cent higher than on the same date five years ago and 330 per cent higher than a decade ago.

The most significant driving force behind gold’s sustained bull run has been the growth in investment demand.

However, although gold is now increasingly in the spotlight, it was for many years neglected by the vast majority of investors, in a financial environment characterised by a glut of exciting new products, and the promise of bountiful and rapid returns. Even those attracted to its long-term wealth preservation and inflation hedging properties often found it cumbersome to access, not wishing to be burdened by issues of physical ownership, storage and security. Fortunately, the arrival of the gold exchange traded funds (ETFs) did much to address these concerns, simplifying access to gold as an asset by allowing it to be bought and traded on stock exchanges just like any share. Gold ETF holdings now represent over 1950 tonnes of gold, currently worth more than USD75 billion.

We should also not forget the resurgence in demand for physical gold. This has been particularly strong in the West, where retail investors, shocked at the fragility of banks and financial markets, have sought security in gold ownership. European demand for gold bars and coins over the last few years has exceeded 200 tonnes per annum, whereas in previous years tonnage demand across the whole continent often failed to rise above single figures. It can be argued that, while many of these buyers undoubtedly turned to gold as an ‘asset of last resort’, their motivations were underpinned by other qualities much sought after by investors but frequently lacking in many investment products on offer: simplicity, transparency and security.

Although this reawakening of investor interest in gold has helped drive the price to new highs, gold’s primary appeal as an investment lies not in the generous returns of recent years, but in its independent tendencies which help reduce risk. Investors are increasingly realising that, over time, they will need to address the vulnerability of their assets to both recessionary pressures and the corrosive effects of inflation. Furthermore, given the experience of the last few years, increasing attention is now being given to ‘tail risk’ – basically, the impact on investments of previously unforeseen or underestimated events. Unfortunately, the vast bulk of portfolios contain few investments that can withstand and prosper in all these circumstances.

The events of the last three years have exposed these inadequacies. The reality is that many investors were simply too narrow in their focus, investing in assets with drivers which are closely linked. In other words, they had failed to adequately diversify their investments and were therefore overly exposed to negative risks.

Portfolio diversification is used to mitigate risk by ensuring an investor takes allocations in a range of assets, the values of which move independently of one another. This provides the portfolio with greater balance, allowing it to be more robust and stable when faced with a range of market conditions.

When most commodity prices fell in tandem with oil, gold did not respond in the same way. Similarly, when hedge funds and property prices plummeted, gold held its positive price trend. Investors are increasingly acknowledging that they need an asset, such as gold, that can act as a counter-balance to the riskier investments that they may be drawn to in pursuit of wealth recovery.

This resilience and lack of correlation with other assets is rooted in the fundamentals of the gold market. Gold is many things to many people – a luxury good, a commodity and a monetary asset – and its price is therefore driven by a very wide range of factors, which cause it to respond very differently to market forces and economic conditions than most other investment vehicles.

Gold’s relative lack of risk is also a key factor in helping restore investor confidence. Gold, as a real asset, carries no default or counterparty risk– its value does not depend on someone’s ability to pay and it cannot be debased. However, unlike many other real assets and so-called ‘alternative’ investments, gold can be sold quickly and with relative ease as the gold market is global and highly liquid.

The role of gold as an ‘insurance asset’, providing enduring security that can reassure investors that their savings and wealth are protected by investment strategies that are sufficiently robust, is, of course, nothing new. But, at less than 1 per cent of global assets, it is also true that gold has probably slipped from the minds and portfolios of many, if not most, investment professionals. It can be argued that now is the time for investors and wealth managers of all kinds to redress this neglect. They should remember that, on the road to recovery, they may well be attracted to riskier investments, but they first need to be confident that their asset choices provide a stable foundation for sustained growth and are sufficiently cushioned against a range of risks. This is the confidence gold can offer.