PORTFOLIO EFFECT ON GOLD IS JUST STARTING / MACLEOD FINANCE

Portfolio effect on gold is just starting

With western capital markets only just beginning to realise that gold is the best performing asset in Q1, portfolio flows into gold ETFs will have a dramatic effect on the gold price. 

ALASDAIR MACLEOD

This article assesses investors’ exposure to gold in western capital markets. 

It comes in three forms: bullion itself, gold ETFs, and gold mining corporations. 

The findings show that exposure to gold and related investments is significantly less than commonly thought, raising questions over what happens when investment managers attempt to rebalance their portfolios away from poorly performing sectors in 2025.

Quantifying the problem

Portfolios in western capital markets have almost no exposure to gold, and minimal exposure to gold ETFs and mines. 

While equity markets have been strong, this has not been an issue for investment managers. 

Furthermore, the poor performance of duration bonds has encouraged them to overweight equities and underweight bonds. 

With the exception of the UK and some European equity markets, the first quarter of 2025 has been a disaster for these portfolios, as the table below illustrates.

The stand-out exception has been gold. 

And silver has risen 17%, even beating gold. 

The point behind this exercise is that at the end of Q1 which is just days away, investment managers will want to demonstrate not just that they have not lost too much value, but that the portfolios under their management are planning to increase exposure to gold and gold mines. 

Undoubtedly, this is driving the current inflows into gold ETFs, recorded by the World Gold Council in the chart below.

The dark blue is North America, which in February added 72.2 tonnes equivalent, while Europe (light blue) having added 39 tonnes in January only added 2 tonnes in February. 

Asia added 24.4 tonnes in February. 

This tells us that it was only last month that investment managers in the US began reweighting their portfolios in favour of gold.

According to market analyst MSCI, global portfolios at end-2023 were worth $270.7 trillion, 44.5% being US-managed, and 35.7% being managed in other developed markets. 

That amounts to $120.5 trillion and $96.6 trillion respectively.

In a report for the Norwegian Ministry of Finance dated April 2024[i], MSCI estimated physical financial gold holdings to be about $5 trillion, including central banks and ETFs, with a further $1 trillion of derivatives. 

Taking central bank holdings of 36,197 tonnes and 3,113 tonnes in ETFs at the time of the report, that leaves an estimated 39,000 tonnes of what MSCI described as investment gold.

These figures are likely to be unreliable, because they are derived rather than recorded, and no one can know the true figure. 

But we can say that investment gold is unevenly distributed with the large majority of portfolios by value having very little or no exposure at all, while some, such as Asian wealth funds have acquired substantial hidden bullion reserves.

For example, China is thought to have in excess of 20,000 tonnes spread round various government accounts, and Russia a further 10,000. 

Taking these figures leaves precious little actually in portfolios based in North America, Europe, and Japan where physical gold is not a regulated asset and therefore ownership discouraged by regulators.

There is a better way of looking at it. 

Because it is not a regulated investment, the amount of gold held in investment portfolios in North America and developed markets is unlikely to be significantly greater than that reflected in ETFs — perhaps a few hundred tonnes at most. 

At end-2023, ETFs held 3,226 tonnes worth $210 billion, which was 0.08% of MSCI’s $270.7 trillion total. 

Including a likely figure for directly held gold in portfolios, it is fair to assume that exposure to gold and ETFs is only 0.1% on average.

Gold derivatives

In the report for the Norwegian Finance Ministry, MSCI stated that the World Gold Council estimated gold derivatives to be valued at $1 trillion at that time, nearly five times the bullion backing ETFs. 

This figure is likely to have been taken from the Bank for International Settlements, and the chart of total gold derivative values over time are illustrated in the BIS chart below.

We should point out that gold derivatives are not commonly held in portfolios, counterparties mainly restricted to banks and hedge funds. 

Bank positions are significantly larger than those of hedge funds, which being broadly confined to Comex futures when longs in the managed money category were valued at only $22 billion at the time of the MSCI report.

Therefore, for the western investment portfolio universe, derivatives can be ignored.

Mines are usually the gold investment of choice

Traditionally, investment managers have sought gold exposure through substitutes in the form of mining corporations. 

The sector has badly lagged the rise in the gold price, demonstrating Investment managers’ extreme commitment to momentum investing at the expense of value.

Longstanding investor disinterest in the sector has led to brokers cutting their research efforts covering mining generally, while boosting analysis of other fashionable investment categories such as technology and financials. 

Consequently, investment managers are only open to buying the established gold majors. 

The combined capitalisation of the ten largest gold mining corporations is less than $300bn, while the top 112 companies are valued at only $450bn.

As a proportion of the MSCI’s $217.1 trillion value of US and other developed nation portfolios, the entire gold mining universe represents only 0.21% of that total.

Summary and conclusion

· Portfolio exposure to the best performing asset class in Q1 is virtually non-existent, wrongfooting investment managers badly.

· A likely figure for US and developed nations’ portfolios combining bullion, ETFs, and mines is of the order of 0.3% of total assets under management, ignoring hedge fund derivative positions which are a small portion of the derivative total.

· Q1 portfolio compositions matter for reporting purposes, with significant losses appearing in previously favoured investment categories. 

There is always significant pressure on investment managers to demonstrate that their portfolios have reduced their exposure to poorly performing sectors and that they are reallocating investment to those that are performing.

· Our analysis confirms that there is little free bullion available for portfolio investment and therefore increasing demand for gold-backed ETFs should have a disproportionate effect on the gold price.

· Assuming that the equity bull market is over, the rest of this year will see continuing portfolio reallocation from formally fashionable sectors to gold, silver, and commodities generally. 

Any combined attempt by investment managers to increase their exposure to average just 1% should have a dramatic effect on the gold price and mining share values. 

Bear in mind that in former times a portfolio angled at wealth preservation would aim to have ten times that exposure to gold and gold mines.

· Purely from an investment viewpoint, the bull market in gold, silver, and related substitutes has only just started.