The relevance of gold for Australian investors in 2023

Gold, in Australian dollars (AUD), delivered positive returns in 2022 and so far in 2023. And it has attracted attention: while global central banks bought a record level of gold in 2022, Australia’s sovereign wealth fund also added gold to its portfolio.
Looking ahead, 2023 may create headwinds for most assets as stagflationary pressures intensify, our analysis, based on historical data, shows:

• gold has historically posted superior returns during stagflationary periods
• gold can also help super funds achieve their “CPI+X%” objectives and enhance risk-adjusted returns.

Most assets suffered drawdowns in 2022

Last year saw one of the biggest market storms in decades amid high inflation and hawkish central banks. While the MSCI World Index experienced its worst year since 2008, global bonds, proxied by the Bloomberg Barclay Global Aggregate Index, recorded their largest annual loss ever. Australian assets were not spared either. Both local equities and fixed-income assets witnessed pullbacks. But gold delivered positive returns (+6%, in AUD), mainly driven by factors including local currency weakness, geopolitical uncertainties, and inflationary concerns (Chart 1).

So far in 2023, gold, in AUD, continued to post positive returns (+1%).¹ As our 2023 Gold Market Outlook noted, market consensus of a mild recession ahead should keep gold stable with some upside potential. And market developments so far have matched our baseline scenario.

Gold’s defensive ability, among other qualities, has attracted institutional investors’ attention recently. In its recent position paper, the Future Fund, Australia’s sovereign wealth fund, announced the addition of gold to its portfolio. As mentioned in the paper, challenges such as high inflation levels and the weakened defensive nature of foreign currencies may have prompted its decision to buy gold (Table 1).

Table 1: Future Fund’s summary of portfolio implications and its reactions

Source: Future Fund, Position Paper – The death of traditional portfolio construction?, December 2022

Bumpy road ahead

In 2023, markets may be vulnerable to negative shocks – notably stagflation (Chart 2). This was a key concern shared by the Future Fund, which highlighted that we may face an environment where inflation remains elevated and growth slows in the coming years. And this scenario could be amplified by factors such as geopolitical conflicts.

In Q4 2022, Australia’s quarterly consumer price index (CPI) rose 7.8% y-o-y, the fastest pace in 32 years, and topped economists’ consensus expectation of 7.5%.³ As the Reserve Bank of Australia (RBA) noted in its February meeting, while inflation rose higher than expected, wage growth continued to pick up – which could put further pressure on the region’s CPI.

In the meantime, the RBA dialled down its future growth projection further, to 1.5% over 2023.⁴ Slower global growth and tighter financial conditions were cited as main concerns (Chart 2).

Cross-asset implications

Elevated inflation can, broadly speaking, create significant issues for investors. For instance, the correlation between bonds and equities, accounting for the lion’s share of Australian super funds, tends to rise during high-inflationary periods. Gold, on the other hand, remains an effective diversifier as inflation rises (Chart 3).

In fact, gold has long been considered a hedge against inflation, and historical data confirms this (Chart 4). Also, the annualised return of 7.6% in AUD over the past 20 years has outpaced the Australian and world CPIs.⁵

Additionally, stagflationary pressure poses challenges for institutional portfolios. Stagflation can severely disrupt financial markets and hamper the performance of major assets. But historical data shows that gold, a safe-haven asset, has benefited investors with attractive returns during such periods (Chart 5).

Gold helps achieve return targets and enhance portfolio performance

While we acknowledge that the benchmark test introduced by the “Your Future, Your Super” reform (YFYS) in 2020 has created a number of challenges for super fund managers – notably introducing performance mismatches across certain asset classes resulting in unnecessary tracking error at the portfolio level – Australian investors could utilise gold to cope with above-mentioned macroeconomic challenges, as the Future Fund did.

Moreover, superannuation funds continue to be subject to a multitude of other performance measures, particularly the fund’s own target return for members (typically CPI+X%). The inclusion of real assets such as gold could help meet this objective and protect the real value of members’ savings over time (Chart 6).

And historical data suggests gold is also able to improve an average super portfolio’s performance (Chart 7).

Conclusion

Gold, in AUD, has delivered a steady return in 2022 while major assets including equities and bonds plunged. Its stability and defensiveness, among other qualities, have caught global and local institutions’ attention.

Looking at 2023, we see potential challenges of elevated inflation and an economic slowdown, key ingredients of stagflation. This could severely disrupt financial markets and hurt investors’ portfolios. By examining past data, we found that not only can gold remain an effective equity risk diversifier when inflation is elevated, it also posts superior performances during the stagflationary environment.

Furthermore, gold strategic role in Australian super fund portfolios may increase in importance as it helps achieve their CPI+X% target and enhance risk-adjusted returns.

Footnotes

¹ Based on the LBMA Gold Price PM in AUD as of February 2023.

² Future Fund, Position Paper: The death of traditional portfolio construction?, December 2022

³ For more, see: Australia Inflation Rate - 2022 Data - 2023 Forecast - 1951-2021 Historical - Calendar (tradingeconomics.com)

⁴ For more, see: Statement by Philip Lowe, Governor: Monetary Policy Decision | Media Releases | RBA

⁵ For more, see: Gold Price Returns | Gold Prices | World Gold Council