Home / Opinion / Gold set to shine for SMSFs seeking portfolio protection

Gold has never held strong investment appeal for SMSFs, despite being seen as a hedge against inflation. With the precious metal beginning a so-far volatile 2023 full of steam, SMSFs looking to preserve capital have several reasons to consider incorporating gold into their portfolios.

For self-managed super funds (SMSFs), it’s a perennial question – how best to preserve capital in volatile markets.

Particularly for those in self-funded retirement, the past year has made this concern even more pertinent, with equity markets tumbling – the bellwether S&P/ASX200 index fell 7.26 per cent between 4 January and 30 December 2022 – and retail property retreating 8 per cent since May. Higher returns from term deposits offered cold comfort as the inflation rate in Australia landed at 7.8 per cent for the 12 months through December 2022.

In this volatile environment, gold and bonds – traditional options for preserving capital in troubled times – are increasingly becoming part of the investment equation. 

Yet neither of these assets has ever greatly appealed to SMSFs. Australian Taxation Office statistics show that as of September 30, debt securities only accounted for $10.5 billion, or 1.3 per cent, of net SMSF assets of $833 billion. Gold doesn’t even rate a mention on the regulator’s asset list, although undoubtedly some funds are exposed to the precious metal via exchange-traded funds, listed gold miners or managed funds.

Why debt, especially gilt-edged government debt, has not had greater appeal to SMSFs defies a simple explanation. Debt investments provide regular interest payments (typically every six months) and, if held to maturity, repayment of the face value of the bond.

But what if SMSFs want to sell bonds before maturity? This is where the inverse relationship between yield and price comes into play. As yields rise – as is happening now with central banks’ monetary policy tightening – prices fall.

And the falls can be sharp. In the first half of 2022, back-to-back quarterly losses of nearly 18 per cent in the Dow Jones Corporate Bond Average led to the third worst six-month period since 1929, ending a 40-year bull market in debt – one of the longest in history. It perhaps helps explain why SMSFs have shied away from this asset. 

What then gold? Historically, it has been seen as a hedge again inflation. But the wisdom of this investment maxim can be argued.

In the 1970s, gold played its inflation-hedge role to perfection when oil shocks drove US average annual inflation to nearly 9 per cent between 1973 and 1979. Over that period, the precious metal turned in a gold medal performance, with an impressive 35 per cent annualised return.

Yet from 1980 to 1984, gold dropped an annualised 10 per cent, despite an average inflation rate of 6.5 per cent. Last year, the gold price hardly moved even as prices rose sharply in most industrialised countries, with the US averaging a 6.5 per cent inflation rate.

But even if the inflation-hedge argument has its flaws, digging a little deeper can reveal why gold can still serve as a strong store of value over the long run.

It certainly began 2023 full of steam, peaking at US$1,955 (A$2,818) on February 1 and prompting gold bugs to declare another rally. Although that might prove premature – the price has since eased to US$1,876 (A$2,704) – the reasons prompting such speculation remain valid.

First and foremost, while the price of gold can be volatile in the short term, it has always maintained its value over the long term. It has outperformed other major assets over the past two decades and been competitive over other time periods.

Second, there is a rising demand for physical gold, especially jewellery, in the two fastest growing middle-class markets in the world – China and India. The World Gold Council’s latest Gold Demand Trends report reveals that annual gold demand (excluding over-the-counter) increased 18 per cent in 2022, hitting 4,741 tonnes – the highest annual total since 2011.

Not only is retail demand high, but central banks have been increasing their reserves in the face of geopolitical uncertainty, notably the Russia-Ukraine conflict, ongoing COVID-19 fears and inflationary pressures. It is believed the People’s Bank of China returned to the market late last year after sitting on the sidelines for three years, adding 62 tonnes to its reserves. And there has been growing demand from jewellers – which account for about half of all demand – and technology companies.

Also supporting the outlook for gold is the fact that rising expectations the US will trim interest rates in 2023 has taken the shine off the US dollar, which will make gold more attractive in other currencies. After all, an appreciating greenback was partly held responsible for a tepid gold price in 2022, despite rising inflation.

Finally, gold helps diversify a portfolio. It has very little correlation with other assets, reducing a portfolio’s overall risk. Although it does not produce income like bonds do, it does shield SMSFs from the risks inherent in debt – counterparty, default and market.

All these arguments could count for naught. This year could be repeat of 2022, when the gold price trod water. Worse still, it could fall. But the gold bugs will also say that over the decades (indeed millennia), this precious metal has held its value where bonds and currencies often have not – a legitimate argument for having a percentage of gold in any portfolio, especially one looking to preserve capital.