Diversification with a heart of gold

By Joe Aylott, Multi-Asset Strategist

Gold has played a central role in commerce, diplomacy and wealth preservation for millennia. From ancient Egypt to the Roman Empire, it has been used to signify power, settle international obligations and mint high‑value currency.

Across the ages and immeasurable global changes, gold has retained its role as a universally recognised store of wealth. For modern investors, it remains a constant in an increasingly complex world.

At Coutts, we have re-introduced gold into our multi-asset discretionary investments through a modest, strategic allocation. Examining the precious metal through our Anchor and Cycle investment process – which blends long-term analysis with tactical agility – we found that even a small weighting could improve long‑term outcomes. It has the potential to enhance portfolio robustness and help mitigate key market risks.

Over the past year, gold has undergone a dramatic appreciation against a backdrop of chronic uncertainty. Tariffs, geopolitical tensions and elevated government debt have all weighed on confidence.

Gold rose from around $2,600 per ounce in December 2024 to more than $5,500 per ounce last month – a new all‑time high. Prices then softened amid some profit taking and the prospect of a new US Federal Reserve Chair who could favour higher interest rates. Prices remain volatile, but are still elevated by historical standards.

For us, however, gold’s true value lies less in short‑term movements – which are often erratic (more on that later) – and more in its powerful diversification characteristics.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

Gold should be viewed as part of the diversification toolkit. When it comes to hedging recession risk, we believe that high‑quality government bonds remain the most effective instrument. Their relative security often makes them the warm, dry shelter investors flock to when economic storms brew overhead.

While recession is not our base case currently – our analysis shows the economy now in an expansion phase – it is prudent to be prepared should this change. Even though we don’t currently expect bonds to perform as well as equities over the coming months, we continue to hold them for this important reason.

Growth risks are not the only challenges investors face. Risks around geopolitics, inflation and fiscal sustainability are also significant – increasingly so in recent years – and we expect this to continue. This is where gold could shine as a diversifier.

Historically bonds and gold move in a different direction to equities. However, bond-equity correlations have increased in recent years due to elevated inflation and more uncertain central bank policy. Under these conditions, gold’s ‘safe haven’ status and low correlation to equities could become increasingly valuable.

Gold also has a long history of delivering positive returns during severe equity drawdowns, offering support precisely when investors need it most.

It is these characteristics – low correlations and a decent track record during periods of stress – that we examine to assess the value of any potential diversifier.

Looking ahead, several structural tailwinds could continue to support gold.

Fiscal deficits across developed markets remain elevated. Within the G7, government debt‑to‑GDP ratios range from 64% in Germany to 237% in Japan, with six of the seven economies above 100%.

These dynamics raise periodic concerns about fiscal sustainability, contributing to bouts of volatility in government bonds. In such environments, investors may increasingly turn to gold as a diversifier.

A second tailwind is continued central bank buying. Since 2022, central banks have accumulated substantial quantities of gold as they seek to diversify reserves away from US dollar‑denominated assets. While forecasting future purchases is difficult, we do not see this trend reversing.

Despite its ancient pedigree, gold remains a small financial market, which partly explains the price swings observed in recent months.

The World Gold Council estimates that around 219,890 tonnes of gold have been mined throughout history. But only about 90,000 tonnes are accessible to financial markets – bars, coins, exchange traded fund holdings and central bank reserves.

At an indicative price of $5,000 per ounce, this equates to a market value of roughly $14.5 trillion, compared to a global equity market of approximately $125 trillion and fixed income figure of around $145 trillion. 

Such episodes highlight why tuning out short‑term market moves is important, but quite difficult. That is why we see gold as part of the Anchor element of our process (strategic, long term) rather than Cycle (tactical, short term).

We think modest strategic allocations could improve the robustness of portfolios or funds. But extreme, and sometimes opaque, price moves are a consequence investors must bear in exchange for improved diversification.