World Gold Council
Blockchain technology, the distributed ledger mechanism that underpins cryptocurrencies such as bitcoin, is genuinely innovative and could have wide-ranging applications across financial services and beyond. In the gold market, various players are exploring blockchain in the context of transforming gold into a ‘digital asset,’ tracking gold provenance across the supply chain, and introducing efficiencies into post-trade settlement processes. Such applications are typically built on private blockchains operated by trusted parties rather than using bitcoin or other ‘public blockchains’.
Gold as a strategic asset
In our view, bitcoin and cryptocurrencies more generally are not a substitute for gold. Gold is a tried and tested effective investment tool in portfolios. It has been a source of returns rivaling that of the stock market over various time horizons; it has performed well during periods of inflation; it has been a highly liquid, established market; and it has acted as an important portfolio diversifier, exemplifying negative correlation to the market during downturns.
Cryptocurrency’s performance has, until recently, been remarkable, but its purpose as an investment seems quite different from gold. Cryptocurrencies have yet to be tested in multiple markets. Since bitcoin’s inception, the stock market has been in an incredibly low volatility, trending, bull market, with very few pullbacks. The crypto-market is young, and liquidity is scarce. Its price behaviour at this point, while still attractive to many investors, seems to be driven by high return expectations.
Challenges for bitcoin
Despite the impressive rise of bitcoin in 2017, its increased price volatility and complex mining process have limited its demand. Bitcoin isn’t regulated, thus making some investors skeptical of investing in it. The other big challenge for bitcoin in the future is its complex mining process and energy consumption. If bitcoin replaced cash in the future, the complexity of the mining process would have to ease, and energy consumption would have to be reduced. Although many believe that cryptocurrencies could replace gold, the evidence may say otherwise.
Gold offers investors diversification benefits since it has a low-to-negative correlation with other asset classes, as we saw in Part 1 of this series. Empirical evidence shows that gold offers positive performance during a market slump. Gold offered annualized returns of ~7% during the S&P 500 (SPY) drawdown years.[1. Drawdown years were 2000, 2001, 2002, and 2008 when the S&P 500 recorded negative performance.] The S&P 500 and emerging markets (EEM) had returns of -20% and -23%, respectively. In its Commodity Markets Outlook report for October 2017, the World Bank presented its annual projections for gold prices, as shown in the chart above.
Gold acts as a store of value and allows investors to hedge their investments to earn positive returns. Gold investment options vary, from ETFs to investments in jewelry or gold stocks, including New Gold (NGD), Eldorado Gold (EGO), and Franco-Nevada (FNV).