How to hold gold

But record valuations do raise questions about how much further the price has to go, and whether gold is still a reliable diversifier. The form of exposure you take will also have a major influence on how well the position plays out.

Glass half empty

It is worth acknowledging some of the metal's downsides. Edward Park, deputy chief investment officer at Brooks Macdonald, notes that gold “acts like an extremely long duration bond which provides a static store of wealth where rate expectations and safe haven yields have plummeted”. He believes developed markets may be close to peak monetary accommodation following this year’s rate cuts and bond buying. This would diminish the outlook for gold and government bonds.

For others, long-running drawbacks persist. Simon Black, head of investment management at Dolfin, warns there is “no fundamental value” to gold. Luna Investment Management chief investment officer Alex Brandreth, meanwhile, struggles with the fact that it offers no yield.

Gold prices could also grow overly reliant on investor sentiment amid rocketing demand for gold exchange-traded funds (ETFs). As Fawad Razaqzada, analyst at ThinkMarkets, notes: “With everyone talking about gold amid rallying prices, retail money has been flooding into precious metals funds. Usually this doesn’t end very well.”

On the up: gold-backed ETF demand in 2020

However, a case can still be made for the metal. Interest rates and government bond yields are extremely low and 'risk-free' rates of interest are either miniscule or negative after inflation. This reduces the opportunity cost of holding gold, which yields nothing.

A combination of massive fiscal stimulus and loose monetary policy could also create inflation – something that often benefits gold. Asset manager Unigestion has found that between 1974 and 2017 gold delivered an average return of 10 per cent during periods of inflation. The mass printing of money can also erode the value of currencies, bolstering gold's appeal.

Not all are convinced of its reliability as a hedge against inflation. IC economist Chris Dillow recently argued that the metal’s price should have fallen amid a recent drop in inflation expectations if it were regarded as an inflationary hedge. But investors should note that markets have not necessarily accounted for the prospect of inflation thus far: government bonds, which run into trouble in periods of inflation, have remained expensive.

More broadly, gold could hold up as a safe haven asset when few others look appealing. Cash struggles versus inflation, government bonds look unattractive in many respects, and the US dollar has shown signs of weakening.

Direct exposure

Having pure exposure to gold can be the most reliable way to hedge against stock market falls, and buying the metal itself can be relatively simple. The Royal Mint, among others, offers a range of gold coins and bars. Coins that qualify as legal currency are exempt from capital gains tax (CGT).

But while holding gold may appeal for aesthetic reasons it incurs extra costs and complications, from insurance to storage. Investors may, instead, want to stick with ETFs as a pure play on gold price moves. Physical ETFs, which hold the actual asset, are the best direct option. Synthetic ETFs, which use derivatives as a source of exposure, rely on a third party to compensate them for the gains associated with an asset, creating extra risk.

As the chart below shows, physical gold ETFs proved their worth in this year's sell-off, while funds exposed to gold mining equities suffered heavily.

Choosing between hedged and unhedged share classes will also influence returns, because gold is a dollar asset. When the dollar is strong versus sterling, this will flatter unhedged returns. A hedged share class will suffer when the dollar is strong but pays off if it weakens against sterling. However, this is complicated by the fact that gold generally performs well when the dollar is weak.

More generally, it pays off to choose ETFs which are large, easily traded and cheap. Invesco Physical Gold (SGLD), which features in our Top 50 ETFs list, stands out with a charge of 0.19 per cent and billions in assets. A sterling-hedged version of the same product launched in July, with a ticker of SGLS. Other providers, including iShares, WisdomTree and Amundi, offer rival products.

Mining shares

Gold mining shares tend to be much more volatile than the metal itself. Their shares can get caught up in market volatility, while the companies themselves can struggle in the difficult economic conditions that sometimes accompany a sell-off. But shares can enjoy huge gains in the wake of price rises.

“The benefit tends to be amplified from gold price rises unless you have a stock market crash when people sell stocks, including gold miners,” says Andrew Cole, multi-asset manager at Pictet Asset Management.

This dynamic has been clear to see in 2020: the VanEck Vectors Gold Miners UCITS ETF (GDX), which tracks the NYSE Arca Gold Miners index, fell by nearly 20 per cent in sterling terms in this year's sell-off, but has made huge gains since.

The IC’s commodities specialist, Alex Hamer, has assessed a variety of mining shares in the box below. However, gold stocks may be best accessed via a diversified fund because of the risks involved.

A passive approach has been hard to beat: just two active funds come out ahead of the VanEck ETF over a five-year period. LF Ruffer Gold (GB00B8510Q93) has fared well: in recent times the fund has focused on Africa and North America, with a broader preference for mid and small-caps. The fund had 44.9 per cent of its assets in mid-caps at the end of June, with 31.1 per cent in smaller companies. Its biggest holdings were Centerra Gold (CG:TOR) and Gold Fields (GFI:JNB)

Ninety One Global Gold (GB00B1XFGM25), the second-best performer, had more than half its assets in Canada at the end of June, with top holdings including Agnico Eagle Mines (AEM:TOR) and Kirkland Lake Gold (KL:TOR). 

The Ninety One fund also had a small allocation to silver, which is not unusual for gold funds. Many tend to have some flexibility to invest in precious metals apart from gold. The same can apply to passives: the VanEck ETF's index can include companies that also focus on silver.

Finally, investors should remember that they can get gold exposure in funds with a broader remit, although they are sacrificing an element of control over asset allocation. This can include broad resources funds, but defensive multi-asset funds such as Troy Trojan (GB00B05KY352) and Ruffer Total Return (GB0009684100) have also benefited from various forms of gold exposure this year, while some equity funds have turned to the precious metals sector as a source of returns. In UK equity income, the Diverse Income Trust (DIVI) has listed some gold miners among its recent top holdings.