Over the last decade or so, there has been a veritable explosion in the number of Australians setting up Self Managed Super Funds (SMSFs), and taking control of this key financial asset.

Whilst transparent costs have been on the key drivers, investment flexibility has also been important, with the ability to buy into asset classes that retail and industry funds simply will not allow another driving force behind Australia’s ever growing SMSF army.

Whilst direct shares, property and term deposits are the major assets that SMSF Trustees tend to build their portfolios around, physical gold and silver are also allowable investments in a SMSF, and at ABC Bullion, we’ve seen a huge increase in the number of Trustees opening accounts with us, so that they can incorporate precious metals into their portfolio.

Below, we list the eight reasons we think our SMSF clients have made the right choice to incorporate bullion into their portfolio, and why other trustees may wish to follow suit

1. Gold has very strong long-term returns

Anyone who has held a core position in gold bullion for the last decade or so has done incredibly well, despite the correction we’ve seen since 2011.

This is captured neatly in the following table, which highlights both the short, medium and longer term returns of a variety of asset class returns, including the areas where both SMSF Trustees and large superannuation and pension funds tend to concentrate their investments in.

Table 1. Asset Class Returns to June 2014

As you can see, over a 7-10 year period, gold has outperformed all the major asset classes, and in some cases by a considerable margin.

Whilst more traditional assets have rallied strongly in the last couple of years, anyone devising an investment strategy for their SMSF in the coming years should be looking at gold, for its medium to longer term returns stack up strongly.

2. Gold is better than Cash in the Bank

Gold has long been a monetary savings asset. Even new investors are typically aware of a time when the world operated under a ‘gold-standard’, where money itself and gold were essentially interchangeable.

Whilst we don’t live operate under a ‘gold standard’ anymore, gold is still used as money in certain parts of the world, and indeed central banks and the like continue to hold, and to buy vast quantities of the precious metal.

Over the long run, this has proved a very sensible decision, for the capital appreciation in the price of gold has comfortably outperformed the income one would have earned keeping their money in the bank, as the following table illustrates.

Table 2. Gold vs. Cash over the medium to long run

*note that we use 44 years as the ultimate long term return as its essentially 44 years since the world left the Gold Standard. Up until then, one could literally convert their dollars into ounces of gold at a fixed price.

Considering the significant tax advantages that can come with investing in gold vs. paying income tax on interest earned annually, the long term net returns from gold would be even more beneficial for average investors.

3. Gold Returns are Strongest when Real interest rates are low

Not surprisingly, precious metal prices tend to do best in environments where real interest rates (the official cash rate minus the inflation rate) are low, or even negative, like they are all around the world today.

The rationale behind this is easy enough to understand, and is due to “opportunity cost”. The higher the real rate of return the bank will pay you for lending/depositing money with them, the less attractive it is to own gold, for the “opportunity cost” of foregone interest income will be high.

The opposite is also true. If, like today, the bank is effectively paying you less than the rate of inflation, there is no “opportunity cost” in holding gold, which is a much better protector of real purchasing power.

History has shown that a 2% real rate of return is the “tipping point”. Above that and gold and silver tend to weaken, but below that, prices tend to rise substantially.

Indeed in environments like today, where real interest rates the world over are effectively zero or even negative, gold prices have on average, appreciated by over 20% per annum in AUD terms, far outperforming stocks, bonds and cash in the process, as the table below shows.

Table 3. Performance of gold, stocks, bonds and cash in environments where real interest rates are 2% or less

With economic growth still very weak the world over, global debt levels even higher than when the GFC hit several years back, and central banks still needing to provide extraordinary stimulus to the financial markets, its highly likely that we will be in a low to negative real interest rate environment for many years to come.

That will be bullish for gold prices

4. Gold is uncorrelated to Equity Markets.

Generally speaking, SMSF Trustees have a healthy allocation to Australian equities, with ATO data suggesting that on average, some 30% of the total pool of SMSF money is invested on the local bourse, with a similar amount held in cash and term deposits.

Over the last couple of years, this has worked very well, as ultra low interest rates have led to a significant appreciation in the ASX, particularly reliable dividend paying companies like our 4 major banks, Woolworths, Wesfarmers and Telstra.

With cash rates already at record lows, and likely to stay there for some time, many trustees are wondering what they should do with the roughly 30% of their portfolio that they hold in cash.

Whilst buying more shares in dividend paying companies is one option, this only further concentrates the risk in their portfolios, as they are already exposed to share market fluctuations.

Gold provides an attractive alternative, for the simple reason that it has a low correlation to the equity market, unlike other assets such as real estate investment trusts and the like. This means that when and if there is a correction on the stock market, your gold position is likely to hold up quite well, balancing out your overall portfolio.

Most importantly, this correlation tends to be negative when the stock market is falling (i.e. when it really counts), as the following chart, produced by Bloomberg and the World Gold Council shows.

As you can see, when the market was plummeting between 2007 and 2009, the correlation between gold and equities moved into a sharply negative position, protecting overall portfolios.

Indeed, as the table below shows, in the five worst years on the ASX since the early 1970s, the local bourse has given up just under 25% on average. Gold on the other hand has appreciated by just under 40% in the same years.

Sensible trustees are paying attention to these factors, and using gold as a balancing item in their portfolios.

5. Gold is a hedge against the Australian dollar

After an incredible run for the better part of a decade, captured neatly in the chart below, the Australian Dollar could well weaken in the coming years, and by a potentially substantial amount.

As you can see, from the late 1990’s all the way up to 2011, the AUD was in a strong uptrend (albeit with a severe correction when the GFC occurred), more than doubling from around $0.50 vs. the USD, to over $1.10 at its highest point. This was of course driven by the once in a century mining boom, which saw prices for key commodity exports like iron ore, coal and gas soar to previously unseen levels.

The AUD peaked back in 2011, and could well head back into the $0.70 range vs. the USD.

The potential for gold prices to rise substantially in the coming years, plus the likelihood of a lower Australian dollar help make gold a compelling investment for SMSF Trustees, as they will benefit from both the underlying commodity price appreciation, and the correction in the local currency.

6. Gold is both an Inflation and a Crisis Hedge!

Even those who are bearish on gold prices tend to acknowledge that it is a good inflation and crisis hedge.

During the 1970’s and early 1980’s, a period in which annualised inflation rates were often in the double digits, only gold protected real purchasing power.

Shares and the like did go up in nominal terms, and interest rates did rise, but such was the corrosive effect of inflation, that those who left all their money in stocks, or in the bank saw their real wealth deteriorate, especially when tax was taken into account.

The flight to gold in that period was so strong that prices rose by about 25% per annum for over a decade, not only protecting, but enhancing the wealth of those sensible enough to allocate a portion of their portfolio to physical gold.

Since the turn of the century, gold has also come into its own again, partly due to the elevated geopolitical tension we’ve seen, and are likely to continue seeing for some time to come, and also due to the ever-present threat of rising inflation.

Whilst CPI figures the world over are still quite low, central banks have made it very clear they will keep providing monetary stimulation, as higher levels of inflation are the only way out from the unprecedented levels of debt developed market economies are burdened with.

A decrease in the real purchasing power of dollar denominated assets is almost certain in this environment, and sensible investors are increasingly looking to gold as a way of balancing out their portfolio and protecting against these risks.

7. Gold will benefit from rising Chinese and Indian demand

The heart of the physical gold market has increasingly moved to the East in the past decade, with India and China now dominating physical gold demand.

These two countries already purchase over 2,000 tonnes of physical gold each year, driven by both their central banks and their citizens.

Their central banks are building up their national gold reserves as a way of diversifying their foreign exchange reserves, which to date mostly consisted of USD and EUR denominated sovereign debt. Considering those debts now offer record low yields, and are being serviced with printed money, these central banks (and many others in the emerging world) are sensibly choosing to build up their gold reserves instead.

When it comes to the citizens of both China and India, gold has long been a favoured savings vehicle, with gold often used to collateralise loans in India, and over 80% of Chinese viewing gold as a favoured investment asset.

Demand from these sources will strengthen in the coming years, due to favourable demographics, rising incomes and high savings rates, with the World Gold Council forecasting a 20% rise in gold demand in China by 2017.

It is for these reasons that we never tire of saying that when choosing to invest in physical gold, not only do you protect and hedge your portfolio against some of the risks, and unresolved challenges in western economies and financial markets, but you also stand to benefit the rising prosperity of the east.

8. Gold represents an opportunity for outsized gains in a difficult market!

The final reason SMSF Trustees are looking to physical gold and silver bullion in this environment is that they see an opportunity for potentially outsized gains in this asset class, something that is particularly attractive when one considers where other asset markets are currently trading.

Cash, whilst providing trustees with an option on falling markets, is no longer a viable long-term savings vehicle, as purchasing power continues to ebb away due to low interest rates and inflation.

The Australian stock market, once dividends are factored in, is back above its pre GFC level, as is the S&P500 in the United States, and indeed most stock markets around the world.

Bond markets, despite skyrocketing debt levels the world over are also at their highest levels in centuries, whilst Australian property, especially Sydney, has been on a tear lately, with prices near or at record highs and yields at record lows.

Not one of these major asset classes is cheap today, and considering these are the areas where most trustees already concentrate the lions share of their investments, an alternative is needed.

If gold and silver were to repeat the performance of the late 1970’s, when gold, after suffering a mid cycle correction rallied from just over USD $100oz to over USD $800oz at one point, then investors stand to make many times their money on their precious metal holdings.

There are few other asset classes that offer that kind of return potential in the coming years, and this is yet another reason why sensible trustees are allocating a portion of their portfolio to bullion.

Final Comment

To summarise, physical gold and physical silver have a number of bullish factors that combined, should see prices rise much higher in the coming years.

Despite the recent volatility, the secular bull market is still in tact, providing investors with a simple, liquid and transparent way of not only protecting, but building wealth through what will be challenging times.

SMSF Trustees who capture this opportunity are likely to be well rewarded in the coming years.

ABC Bullions Investor Centre contains a wealth of information on the precious metal market, as well as the domestic and global economy. It also contains special reports focusing purely on investment markets, Superannuation and how SMSF Trustees can maximise their portfolios.

If you’d like to know more, please visit www.abcbullion.com.au/investor-centre or feel free to contact our Client Service Team on 1300 361 261.

Disclaimer

This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. Any prices, quotes or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness. This report was produced in conjunction with ABC Bullion NSW.