Between the U.S. Treasury’s declining credit and the euro zone’s ongoing agony, advisors around the world are giving up on cash to move their best clients into hard assets. Truly dynastic time horizons require more focus on wealth preservation, not current income, they say.
The last few months have forced the world’s richest families to contemplate how the fortunes under their control would fare under once-unthinkable circumstances.
In the absence of alternative ways to protect their wealth for future generations, many are buying precious metals -- but they’re being a lot more sophisticated about it than the people who speculate on all the overpriced “collector coins” crowding the Internet.
“Affluent investors are harnessing gold’s unique properties to protect wealth as it is accumulated,” explains David Schrader, a spokesman for the World Gold Council, which tracks global movements of bullion.
Despite the metal's bullish recent performance, Schrader and classic stock bulls like Warren Buffett agree that unless you’re digging the ore out of the ground yourself, gold is not a way to make a fortune.
It does no work, is unlikely to earn better than inflation over the long term and really only matters to bankers and jewelers.
But for those who’ve already made their money elsewhere, a little exposure to gold helps prevent losses by limiting a portfolio’s overall downside risk.
“Think for the best and plan for the worst,” says Steve Young, business development manager at Merit Financial, a specialty dealer in bullion and coins.
“If money managers take a bit of their clients’ money and put it in gold, even if gold goes down to $1 a ton, they’ll still be better off,” he says. “They bought the insurance, and if gold plunges that far, the rest of the portfolio must be flying to the moon.”
Monte Carlo simulations have demonstrated that even before the current gold boom -- 1974 to 2005 -- institutional portfolios derived a non-trivial benefit from allocating 1% to 4% of their assets to bullion.
Better than cash…and practically as liquid
For high-net-worth clients looking for that kind of institutional-grade diversification, gold’s risk/return characteristics make it most likely to replace part of a traditional cash allocation.
While gold has been bouncing around at record levels lately, it still has the potential to appreciate over the long term as Asian central banks and retail investors emerge as net buyers.
But with Treasury bills yielding 3% less than inflation and banks actually charging wealthy customers a premium to hold their deposits, it certainly looks like cash is no prize these days either.
Historically, of course, gold was a royal pain to store, much less actively trade in any but relatively massive quantities.
Here, the rise of exchange-traded funds has given smaller accounts a chance to get extremely convenient exposure to gold, but at the cost of some of the physical metal’s unique risk-hedging qualities.
As the bullion bulls point out, shares of an ETF are backed by ounces of gold, but it’s not much more expensive to own the metal itself.
Steve Young says a world-class vault like the Delaware Depositary Service Company costs maybe 50 to 75 basis points a year and is open to relatively small retail accounts.
Figure an advisor with $500 million under management wanted to buy enough gold to cover 3% of his or her clients’ assets. That would come in at a little under 84 ten-ounce bars or about 50 pounds of bullion, costing $7,500 a year to warehouse.
There are an awful lot of mutual funds that charge a lot more -- the biggest gold fund GLD would charge $6,000 to own the paper -- and all the headaches are taken care of.
Bigger institutions are buying enough gold that it’s worth it to take delivery and handle their own security, Young says.
Protecting your clients from the unthinkable
A lot of advisors hate gold because, paradoxically, all the hype has made the king of asset classes seem a little sleazy.
As a result, simply offering your clients the option to pay an extra few hundred dollars a year to own the physical metal instead of the ETF may establish you as an advisor who’s thinking generations ahead.
Your clients are getting beaten down by the same worst-case scenarios as everyone else, but they have more to lose and a longer time frame to worry about.
Some of these scenarios, like the U.S. Treasury being stripped of its AAA credit rating, have even come true. Others that nobody took seriously a decade ago, like a messy disintegration of the euro zone, have emerged just in the last few weeks as very real possibilities.
Just in the last year, Swiss banks like UBS and Julius Baer have been seeing their high-net-worth clients picking up gold by the ton. Both banks have recommended a strategic allocation of 7% to 10% to precious metals.
“Investment demand for gold has risen steadily over the last decade and is the fastest growing category of global gold demand,” says David Schrader from the World Gold Council.
“That said, gold represents less than 1% of total global investment assets, meaning that the market opportunity for growth in gold investment is still significant.”
Scott Martin, senior editor, The Trust Advisor. Steven Maimes contributed to the research.