Gold as investment

Jos Berkemeijer AAG Johan de Witt lecture , AG-AI June 19, 2012 6/20/2012

GSCG Market Intelligence – All Rights Reserved

Source: Tjeert Mensinga Š golden sky

1

Opening: Overture I

6/20/2012

GSCG Market Intelligence – All Rights Reserved

2

Opening: Overture II (Adagio)

Salt

is essential for life — you cannot live without it.

Salt has been important to humanity for life on this planet.

The word "salary" comes from “sal”, or salt, which was part of the pay of Roman soldiers.

African and European explorers traded an ounce of salt for an ounce of gold — salt was literally worth its weight in gold.

Salt is important to many biological processes, but too much salt can hurt you, but the same can be said of most things — even oxygen and water.

H0: Gold in our asset mix is like salt in our food Q:Do you eat saltless?

6/20/2012

GSCG Market Intelligence – All Rights Reserved

3

Agenda         

Economic Perspective Financial Institutions Increasing Risk Risk Perception & Manipulation Linear Thinking In Between Conclusion Gold as Asset Class Change to Gold New Solutions Conclusion

It takes a 40 meters runway to make a 9 meter long jump….

6/20/2012

GSCG Market Intelligence – All Rights Reserved

4

Economic Perspective Financial Institutions Financial Sustainability at stake The financial sustainability of financial institutions is at stake  To ensure their obligations, financial institutions have to optimize ‘Risk – Return’ and diversify their portfolio  Worldwide, pension fund funding ratios (assets/liabilities) fall short  Insurers, banks and pension funds all have to face more volatile markets, lower interest rates and more systemic risk  All financial Institutions have to meet higher regulation standards to withstand the future economic climate and developments  More diversification power and less counterparty risk are key issues in reducing future risk

6/20/2012

GSCG Market Intelligence – All Rights Reserved

5

Economic Perspective Financial Institutions Economic and Pensions Status Quo • Economic SQ - 2007: subprime crisis - 2007-2008: from housing crisis to banking crisis - 2009-2011: from bank crisis to country crisis - 2011-2012: from country crisis to world Crisis - Declining confidence, negative economic outlook - Future Euro and Dollar is under discussion • Pensions SQ - Increasing attention to governance and compliance - Considerable uncertainty main asset classes (fixed income, equities) - Low interest rates, rising inflation, risk of hyperinflation - Increasing reserve and coverage gaps: no serious signs of recovery - Risk-free discount rate fluctuates and is under discussion - Limited ability to recover from premium, discounts threaten - No clear regulatory framework surrounding Pension Agreement - No clear vision or approach on 'ancient pension rights‘ - Historical ‘proven’ linear based models fall short in modeling the new economy - To what extent are models based upon ‘historical data’ also ‘future proof’?

6/20/2012

GSCG Market Intelligence – All Rights Reserved

6

Economic Perspective Financial Institutions Market Outlook & Key Questions Market Outlook 2012 and Further • Prolonged period of continuing uncertainty with low economic growth • Increasing volatility and covariance of all major asset classes (equities, bonds) • Besides ‘Performance Risk’, other risks demand attention: Economic Risk, Principal Risk, Credit Risk, Collateral Risk, Collateral Margin Call Risk, Country Default Risk, Currency Risk, Euro-Risk, Longevity Risk, Cost Risk, etc.

• Continuously changing regulatory requirements with still uncertain effects: EMIR, Mifid2, Cost Transparency, FTK1/2, AIFMD, etc.

• Risk-free interest rate curve based on the adjusted EUR swap curve varies strongly over time.

• Free lunches: There appear to be no more "safe havens”. Return = Risk Key Questions 1. Is the actual asset mix is still 'in line' with the defined risk appetite?

2. Does the actual asset mix still guarantee the required diversity?

3. Can investing in gold contribute to a sustainable ‘risk return profile’ and an improved diversity?

6/20/2012

GSCG Market Intelligence – All Rights Reserved

7

Increasing Risk Global Pension Asset/Liability Development Asset/Liability Indicator (Global Basis)

L A A/L Source: Towers Watson

Conclusions • Global pension fund balance sheets worsened during 1998-2011, losing 25.4% in the A/L indicator • A/L Indictor lost 4.3% in 2011 • The growth in liabilities exceeds by far the growth in assets Source: Rubbaniy

6/20/2012

GSCG Market Intelligence – All Rights Reserved

8

Increasing Risk Return and Risk Outlook Return Climate Outlook • Low Interest Rates • High Risk Stocks • Increasing Volatility

Advice Commission Parameters • Fixed Income : 4.5% • Listed Stocks: 7.0% • Other Stocks & real Estate: 7.5% 6/20/2012

GSCG Market Intelligence – All Rights Reserved

9

Increasing Risk DNB Dutch Pension Funds Investigation

1. Conclusion DNB Actual performance 2000-2010 is 0.2% better than ‘own defined’ benchmark 2. Other Conclusions • Compound average performance (4.2%) equals arithmetic average performance • Average performance (4.2%) < 10Y Eurobonds performance There’s no pay out on risk!!!

Source: DNB 6/20/2012

GSCG Market Intelligence – All Rights Reserved

10

Increasing Risk EU Government Bonds

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

11

Increasing Risk EU Country Default Risk

Rfr= risk free rate

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

12

Increasing Risk European Stability Mechanism (ESM) Treaty

• • • • •

ESM may demand an unlimited amount of money from European countries ESM is not accountable for what happens to the money ESM has the power to reduce private customer savings There are no compliance or control measures defined ESM has no targets, cost-limitation and enjoys complete immunity.

Line 2012 IF (SPAIN==FALSE) THEN {EUROPE=DEFAULT} ; END 6/20/2012

GSCG Market Intelligence – All Rights Reserved

13

Increasing Risk Longevity Risk Outlook

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

14

Increasing Risk Pension Fund Confidence Level Risk

Discussion 1. A real pension objective puts the nominal pension at risk

2. How sure is your pension?

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

15

Increasing Risk Realistic Pension Perspectives?

Basel III Solvency II

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

16

Risk Perception & Manipulation New Insights Definition of Risk-levels by United States Secretary of Defense Donald Rumsfeld during the Iraq war (2002): What we know • Known Knowns There are known knowns; there are things we know that we know • Known Unknowns There are known unknowns; that is to say, there are things that we now know we don’t know • Unknown Unknowns But there are also unknown unknowns; there are things we do not know we don’t know."

6/20/2012

GSCG Market Intelligence – All Rights Reserved

17

Risk Perception & Manipulation Intermezzo: The Actuary as Risk Manager I

Actuary Anno 1100 A.D. 6/20/2012

Actuary Anno 2012 A.D.

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

18

Risk Perception & Manipulation Intermezzo: The Actuary as Risk Manager II Where are we today?

Actuary Anno 2012 6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

19

Risk Perception & Manipulation We overestimate our Mathematical abilitiesâ&#x20AC;Ś

30 1 2

6/20/2012

37 7 8

42 13 15

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

20

Risk Perception & Manipulation Artificial Discussable Market & Liability Value ‘Market Value Manipulation’ Artificial FED & ECB rates: 0-1% Consequences: 1.

‘Minimalized’ T. Bond rates

2.

‘Pushed’ Stock Markets

3.

‘Push backed’ Inflation

Discussion 1. Market Value is artificial and a pension fund killer 2. 5-10Y Average Market Value Control is more adequate 3. Liability Risk Premium?

6/20/2012

GSCG Market Intelligence – All Rights Reserved

21

Risk Perception & Manipulation Herd Behavior Conclusions Research "Herd behavior and trading of Dutch pension funds"

by Rubbaniy et Al. (2011):

• Robust herding behavior in investments of Dutch pension funds • Overall (LSV) herding level of 8.14% (significant at 1% level !!)

Possible explanations 1. Big Brother Hedge (imitation of large pension funds) 2. Outsourcing: Strategy and Asset management to the same large and reputed asset management firms 3. First Mover Risk Source: Rubbaniy

6/20/2012

GSCG Market Intelligence – All Rights Reserved

22

Risk Perception & Manipulation Supervisory Compliant Risk

STRONG REGULATION 6/20/2012

HIGH “SUPERVISORY COMPLIANCE RISK”

GSCG Market Intelligence – All Rights Reserved

23

Risk Perception & Manipulation Regulation, Part of Risk Management

DYNAMIC REGULATION 6/20/2012

REGULATION BECOMES PART OF RISK MANAGEMENT GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

24

Risk Perception & Manipulation Mean Variance Modeling in Time

Conclusion Mean Variance Models lose power

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

25

Linear Thinking We all think Linear…

6/20/2012

GSCG Market Intelligence – All Rights Reserved

26

Linear Thinking Examples…

Linear mechanisms in life • On a short time scale things don't change much • The best estimate for ‘tomorrow’ is ‘today’ • Results are a (linear) combination of events in the past • Every event now, must have a cause Signs of (dangerous) linear thinking • Mean Reversion • Risk = Volatility = σ =Standard Deviation; • Volatility (σ) is more or less constant in time…

• If a distribution is complex, a normal distribution nevertheless will do fine • Results of the past are an adequate estimator for the future • Mean reversion: Returns continue to go back to an average value over time • Increasing volatility is a good predictor of an upcoming financial crisis • Tail risks are not really interesting or can't be modeled anyway 6/20/2012

GSCG Market Intelligence – All Rights Reserved

27

Risk Perception & Manipulation Risk = Standard Deviation Fallacy

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

28

Risk Perception & Manipulation Standard Deviation: a Poor Measure of Risk

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

29

Linear Thinking Linear Models, Why they are Limited Observations • Financial Crises show increasing Covariance between asset classes • There’s a lack of diversifying power in the asset mix • Shortfall of explaining power of linear based ALM Models Linear Model Crisis Traditional linear ALM models fail in the current market situation (Crisis) • Artificial Interest Rates and Market (Value) • There are no risk free assets: A Risk Free Interest Rate is an illusion • No Witz: Markowitz’s Modern Portfolio Theory falls short Mean reversion, Normality, Unstable asset class correlation, ….

Harry Markowitz • Asset Classes change in risk profile: E.G. Government Bonds • Dynamic Regulation influences investment strategy and tactics • Government Politics influence: QE-inflated unstable future stock markets 6/20/2012

GSCG Market Intelligence – All Rights Reserved

30

Linear Thinking Let’s be Fair…

6/20/2012

GSCG Market Intelligence – All Rights Reserved

31

In Between Conclusion Way out: explore new ways and change system

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

32

Gold as Asset Class All the Gold in the World…

All the above-ground gold in the world (start 2012): • Weight: 165,000 metric tons (165 million KG) • Volume: Fits in a 20m x 20m x 20m Cube • Value: Roughly $9 trillion • Yearly production: 2500 metric ton (2,5 million KG)

6/20/2012

GSCG Market Intelligence – All Rights Reserved

33

Gold as Asset Class Often mentioned disadvantages • • • • • • • • • • •

6/20/2012

Gold has no (direct) return Gold price is volatile Vaulting Gold is expensive It’s only a small gold market The actual price of gold is already high Gold is a bubble Gold is risky and only a short term solution You can’t eat gold Gold is solidified fear sweat (Dutch: ‘gestold angstzweet’) Buying gold is investing in Armageddon Gold gets dug out of the ground, then we melt it down, dig another hole, bury it again and pay people to stand around guarding.

GSCG Market Intelligence – All Rights Reserved

34

Gold as Asset Class Gold Price & US Debt…

6/20/2012

GSCG Market Intelligence – All Rights Reserved

35

Gold as Asset Class Long Term Inflation Hedge •

Gold is no short, but certainly a long inflation hedge

• • •

Nominal gold price (yellow) CPI 1 (red line) is calibrated for gold price at the beginning of the period.

CPI 2 (green line) is calibrated for gold price at present.

Bron: The Gold Report (2009) & WGC: Gold as an asset class (2011) 6/20/2012

GSCG Market Intelligence – All Rights Reserved

36

Gold as Asset Class Real Interest Hedge  Negative real interest rate = price of gold increases  Positive real interest rate = flat gold price

Source: USfunds (2011) 6/20/2012

GSCG Market Intelligence – All Rights Reserved

37

Gold as Asset Class FED’s Gold Backing: The End of FIAT Money?

6/20/2012

GSCG Market Intelligence – All Rights Reserved

38

Gold as Asset Class Gold as a strategic asset (Price, Inflation, CI)

• Chart 1 Gold price increases substantially in crisis scenarios

• Chart 2 Gold as an Euro inflation hedge

• Chart 3 Performance of gold relative to the DJUBS Commodity Index Source: WGC (Dec 2011): Gold as a strategic asset for European investors

6/20/2012

GSCG Market Intelligence – All Rights Reserved

39

Gold as Asset Class Gold as a strategic asset, Low Correlation

â&#x20AC;˘ The main reason why gold adds significant diversifying power is its low or negative correlation with most other assets in an optimized portfolio context. â&#x20AC;˘ We use Conservative return premium assumptions consistent with available long-term data and the presumed role of gold as an inflation-hedge. The more conservative the assumptions the more likely any significant findings may be reliable for long-term investing.

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

40

Gold as Asset Class Gold’s correlation with other Commodities

• Gold is an exceptional commodity and behaves not like other commodities • Gold is the only monetary metal. Silver follows at a distance

6/20/2012

GSCG Market Intelligence – All Rights Reserved

41

Gold as Asset Class Gold as diversifier: WGC Research • Objective: Examine the case for gold as a diversifying asset in the context of a common currency European institutional strategic asset allocation.

• Source: Empirical data from January 1986 through 2010 and more recent data.

• Assumptions: Conservative return premium assumptions that include : assuming that gold and commodities had zero real returns.

• Method: Michaud optimization, an extension of Markowitz MV optimization • Results – gold has a strategic diversifying role roughly comparable to risky assets such as small cap and emerging markets over the long-term.

– A relatively small allocation to gold appears to add useful and likely significant diversification benefits for low to moderate strategic risk levels.

– An allocation of 1%-3% at low to moderate-risk levels may be appropriate for many strategic institutional euro area portfolios.

– For high-risk portfolios some limited evidence for gold is available from our results.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

42

Gold as Asset Class Gold’s Diversification Power I • Gold has a very limited correlation with other asset classes.

• Small gold allocations in the asset mix already improve the Risk-Return of a portfolio?

Source: BlackRock, as of 5/31/10.

• “No Gold” portfolio has the following allocation: 35% US Large Cap, 5% US Small Cap, 20% International Equities and 40% US Fixed Income.

• For the 5% gold, 10% gold and 20% gold portfolios, gold was given those weights respectively and the remaining portfolio allocations were rescaled.

• Portfolios were assumed to have been rebalanced monthly.

• US Large Cap: Russell 1000 Index; US Small Cap: Russell 2000 Index; International Equities: MSCI All Country World Index ex US; US Fixed Income: Barclays Capital US Aggregate Bond Index; Gold: COMEX Gold Spot Price.

Source: The Special Case for Gold (2010) 6/20/2012

GSCG Market Intelligence – All Rights Reserved

43

Gold as Asset Class Goldâ&#x20AC;&#x2122;s Diversification Power II The diversification power of physical gold, the low downside volatility and excellent long term returns, are making gold an interesting De-Risk and ReValuation tool in the ALM approach

Source: Striking Portfolio Balance with Gold Stocks 6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

44

Gold as Asset Class Risk Return and Downside Volatility • Gold: The Best downside volatility and excellent Risk Return Ratio • Gold has a high long-term volatility, however, gold has the best downside volatility (Sortino Ratio) Bron: Precious Metals (2011) • Gold has an excellent Risk Return Ratio (Sharpe Ratio)

6/20/2012

GSCG Market Intelligence – All Rights Reserved

45

Gold as Asset Class Other Financial Properties of Gold I • Gold as Collateral Declining confidence in the financial markets reduces the amount of triple-A securities, used as an investment and as collateral.

Institutional investors, like pension funds, are forced to look for safe investments and cash collateral of high quality.

Large clearinghouses mark Gold as AAA collateral.

Source: WGC:Gold as a source of collateral (May, 2011)

• Gold as liquidity Gold is the most liquid financial product during crises to cover derivative positions, and is 24h a day traded (Comex New York, LBMA in London, Switzerland, 24 hours electronically through Globex, PAGE in Hong Kong )

• Physical gold is portable Physical gold is tangible, portable and transportable and a recognized as international monetary exchange.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

46

Gold as Asset Class Other Financial Properties of Gold II • Gold as a store of value – Gold as a store of value, in comparison to the value stored in government bonds from 1980, shows great potential.

– Value of gold is easy to establish good and gold is physically divisible.

– Since 1911 governments didn’t held as little gold held as they do now.

• Gold has no counterparty risk?

– Gold is an insurance against unexpected shocks in every asset class, because it is the only financial product that has no counterparty risk 6/20/2012

GSCG Market Intelligence – All Rights Reserved

47

Gold as Asset Class Other Financial Properties of Gold III • Gold as Currency Protector – By default or devaluation of currencies, Gold offers adequate value protection – In contrast to currency or other types of investment, the value of Gold never falls to zero – Gold is a currency that is not supported by debt as opposed to other fiat or "paper money" currencies.

– Gold is Basel III Tier 1 candidate, alongside 'sovereign bonds, cash or central bank reserves. “ Gold still represents the ultimate form of payment in the world.

Fiat money, in extremis, is accepted by nobody. Gold is ALWAYS accepted.”

Alan Greenspan, Chairman Federal Reserve, US Congress 1999 Source: Superfund Gold 6/20/2012

GSCG Market Intelligence – All Rights Reserved

48

Gold as Asset Class Gold as Tail Risk Protector , VaR Reduction • Gold, in both good and bad times, is essential (for institutional investors) in stabilizing the return of an existing asset-mix • By adding gold for a limited part(3-9%) in the existing optimal asset mix , ​the Value at Risk can be "substantially reduced” • This property of gold in the portfolio is important for example for a possible devaluation of a real estate portfolio (mark-to-market), haircuts on the bond portfolio and plummeting stock markets.

Source: WGC: Gold as an asset class (2011) & WCC:Gold: Hedging against tail risk (2010, oktober) 6/20/2012

GSCG Market Intelligence – All Rights Reserved

49

Gold as Asset Class Gold as Tail Risk Protector , Crisis Resistance I â&#x20AC;˘ A limited asset allocation of 5.5% in euro gold offers investors a substantial outperformance and protection in times of crisis

Source: WGC: WGC: Gold: alternative investment, foundation asset 6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

50

Gold as Asset Class Gold as Tail Risk Protector , Crisis Resistance II • • •

Especially in uncertain times, gold can increase in value.

In crises of various kinds, the stock market often takes losses at once, while at the same time the development of the gold price is often positive.

As an example, the monthly losses of shares (MSCI World Index) and the development of the price of gold in the same month at various times of crisis.

“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. Deficit spending is simply a scheme for the confiscation of wealth.

Gold stands in the way of this insidious process. It stands as a protector of property rights.”

Alan Greenspan 2011 Source: Superfund Gold 6/20/2012

GSCG Market Intelligence – All Rights Reserved

51

Gold as Asset Class Vision: Prof. Dr. Ruud Kleynen, April 2011

4. Gold: what to say about that 1.

2.

3.

4.

5.

6.

6/20/2012

It looks like gold performed best over the analyzed period Only gold finally was able to meet required return levels based on indexing ambitions Traditional stock markets did not do such a good job Gold could be seen as a safe haven in periods of economic distress Long term expectations for gold look interesting Should the traditional construction of portfolios be reconsidered?

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

52

Gold as Asset Class Vision: Ir Dennis van Ek AAG, CFA , May 2012 Summary Article ‘Investing in Gold’ (Kluwer) 1. Gold is an asset class, no sub-asset class or subset of commodities 2. Gold offers purchasing power protection (scarcity, value quality, worldwide) 3. Gold is the basis of our monetary system 4. Central banks keep gold, no commodities 5. Optimal gold allocation in a portfolio: 5-10% 6. In times of crisis: allocation >10% 7. Long term ‘better 'performance with gold in a portfolio: + 0.15% (equal risk)

DNB Annual Report 2010 In times of financial crisis, DNB’s physical stock of gold serves as an ultimate reserve asset and as an anchor of trust.

Gold is also held for diversification reasons.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

53

Gold as Asset Class Vision: GSCG, April 2011

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

54

Gold as Asset Class Status Quo Asset Mix I Current asset mix Dutch pension Funds • After the WW-II it was still forbidden by law to invest in equities • Since 1980 pension funds have increasingly invested in , • As from 2000, derivatives are increasingly deployed (Risk Mitigation) • Today, the asset mix mainly consists of: Bonds, Equity, Real Estate, Commodities and derivatives.

• Commodities (2011: 0.3%) are usually allocated in ETFs, Futures and Options, as physical allocation entails higher costs.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

55

Gold as Asset Class Status Quo Asset Mix II Gold in the asset mix • Gold is usually seen as a commodity • Dutch pension funds invest only very limited in gold-related financial instruments (including shares) and almost not in physical gold.

• Globally (pension assets $ 31.1 trillion) pension funds average invested 0.15% in gold and another 0.15% in gold-related products • The pension funds that invest in gold do so mainly as a hedge against inflation.

Inflation may also (partly) be covered with Inflation Linked Bonds (ILBs)

6/20/2012

GSCG Market Intelligence – All Rights Reserved

56

Change to Gold The Main Issue FOCUS Pension Journal for the ground crew of KLM, December 10, 2011

‘Is it an idea to invest in gold?’

‘The investment committee could suggest that, but in practice this has not happened yet.’

Nico van Wieringen, Controller Participations at KLM, in conversation with the Chairman of the Participants Council: Frans Reder.

Source:Focus

6/20/2012

GSCG Market Intelligence – All Rights Reserved

57

Change to Gold The Challenge  Gold Ignorance  Due to conventional regulations, a profound lack of awareness, support and knowledge, only a limited number (2) of Dutch pension funds invest in physical gold  Research shows financial institutions mainly consider gold as an ordinary ‘zero return commodity’, are unaware of the unique (financial) properties of gold, however are interested in discussing physical gold investments, but mainly fear first mover risk  Pension fund advisors and asset managers have no or only a limited and passive interest in advising or managing physical gold  There’s a lack of qualified information about gold.

Gold is not an active subject in the education of investment professionals (e.g. VBA)  Gold Challenge  Balanced investment in physical gold reinforces diversification and long term ‘inflation protected return’ without counterparty risk and therefore contributes to the sustainability of financial institutions Source:Focus 6/20/2012

GSCG Market Intelligence – All Rights Reserved

58

Change to Gold Psychological Arguments against Gold I • Lack of Strategy Vision How will the Regulator react when we invest in gold • Big Brother Hedge If other pension funds don’t invest in gold, why should we?

• First Mover Risk Gold is interesting, but we don’t have enough experience • Strongly Delegated Investment Strategy Our investing consultant and/or asset manager doesn’t advice gold • Conservative/Narrow Investment Control & Judgment Procedures We can’t see gold as a sustainable asset class. If gold wouldn’t perform well according target for a longer (>1Y) period, we would exit on gold.

Gold as an asset mix 'stabilizer’ More important than the individual properties of gold, is the overall effect of gold when it is added in the right limited proportion in the meal of the asset mix.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

59

Change to Gold Psychological Arguments against Gold II • Knowledge Aspects – Is this the right timing? Gold is sky high – Gold has no return – What’s the long term return on Gold?

– Gold is simply a Commodity, nothing special – I see gold as an Insurance, tactical (arbitrage) play, but ‘Asset Class’?

• Excuses – Our pension fund is very busy….

– We just did our ALM study, we’ll look at gold the next time (2015) – Our ALM study is already so complicated……..

6/20/2012

GSCG Market Intelligence – All Rights Reserved

60

Change to Gold Outcome Field Research 2011-2012 (I) • Pension Funds, administrators and Actuarial Consultants are open to discussions & information on Gold as asset class • Pension funds are interested but too busy (pension cuts, new pension agreement, mergers, recovery plans, etc.) to act on gold right now • Pension Funds (generally) will not act on gold without a positive advice of their Investment consultant and Asset manager • Pension funds dare not to act, because of Peer Risk and ‘Major Pension Fundhedging’ (first mover risk and keeping score ahead of the top-3 Dutch pension funds) • Regulators (DNB, AFM) are very cautious and point at the risks involved with an investment in gold. Any investments in gold need to be well and upfront underpinned.

• Gold as collateral, Tier 1 and Clearing asset seems to become very important. In the fuzz of daily business only a limited number of pension funds seem to be aware of this 6/20/2012

GSCG Market Intelligence – All Rights Reserved

61

Change to Gold Outcome Field Research 2011-2012 (II) • Asset Managers often don’t view gold as an asset class and will not advice it without an explicit request • Asset Managers are quite often unfamiliar with physical gold and advice alternatives (commodities, ETFs, Shares, etc.)

• Pension funds are limited in allocating gold in case of a 100% mandate (without any own room to maneuver) with their fiduciary manager.

• Gold is not part of the ALM or stress scenario’s • Investment consultants don’t actively advice or recommend gold and are extremely reticent with gold • Main Investment Consultants often operate on basis of linear ALM software, supplemented with some special extreme scenarios.

• Investment Consultants instead of pension boards or pension board advice committees, lead the discussion on the scenarios that will apply in ALM studies.

• The Pension Board’s Risk view is developed while running and discussing the outcome of the ALM scenarios, rather than an upfront vision of the board or including (nonlinear) economic scenario discussions.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

62

Change to Gold Consultancy Dependency, Example Classic Investment Consulting Approach Dialog PB: IC: PB: IC:

Can you advise us on our ALM? Sure.., tell me your “Strategic Goal“ & “Risk Appetite”?

Hmm…, Can you help us on that too?

Of course, that’s what we are for! We’ll be back in a week

IC: Here we’re back with more than 15,000 economic scenarios!

PB: Impressing! What’s in it for Return and Volatility?

IC: It’s all in there, a mix of historical returns, asset mixes, horizons, crises, whatever you can think of…. All designed by our experts!

PB: Wow!! Looks great… But what’s that blue line over there?

IC: That’s one of the more unlucky crisis scenarios …

PB: We don’t like that one, It’s outside our Risk Appetite……

IC: O.K., we’ll “hedge that scenario away”…..

Further we can minimize downside risks with derivatives….

PB: And what’s the strategic asset mix?

IC: It’s all dynamic and risk based, you don’t have to care about your mix, our strategic scenario-generator takes care of that.

It operates like an autopilot on your Strategic Asset Mix. PB: O.K. Thanks a lot. How to set up an investment mandate on this?

IC: Don’t worry, we’ll define a dynamic investment mandate for your asset manager.

PB: And what about reporting?

IC: No problem, we’ll take part in your Investment Advisory Committee (IAC) and pre-comment on every AM-report.

PB: We all agree on all your proposals. Thanks for helping us OUT!!

6/20/2012

Conclusions……

• Pension board Training • Economic Skills • Define your own Strategy and Risk Appetite

GSCG Market Intelligence – All Rights Reserved

63

Change to Gold The canary in the Gold Mine

Japanese pension fund switches to gold May 16, 2012

By Ben McLannahan in Tokyo Okayama Metal & Machinery has become the first Japanese pension fund to make public purchases of gold, in a sign of dwindling faith in paper currencies.

Initially, the fund aims to keep about 1.5 % of its total assets of Y40bn ($500m) in bullion-backed exchange traded funds, according to chief investment officer Yoshisuke Kiguchi, who said he was diversifying into gold to “escape sovereign risk”.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

64

New Solutions Headlines of a Nonlinear ALM approach • Using insights of nonlinear dynamic economics • ALM no longer based on sole ‘Mean reversion’ • Expectations of economic variables, linked to evolutionary dynamics. Thus, limited rational investors and properties of herd behavior and excessive optimism or pessimism can be modeled • Modeling of monetary policy of a central Bank • Extreme uncertainty in the valuation of liabilities by the regulator can be modeled • The impact of change in future laws and regulations as EMIR, Basel III and DoddFrank on the need for liquidity in investment portfolios, and Solvency II on the minimum funding requirements, can be modeled • Time-varying risk premiums on asset categories and covariance between asset classes are integrated • Specific ‘once in a lifetime’ economic events can be modeled • Specific relationships between asset classes and economic development can be simulated and analyzed 6/20/2012

GSCG Market Intelligence – All Rights Reserved

65

New Solutions Examples of other New Semi Nonlinear Models

Discussion Should we, actuaries, become more active on the asset side of the balance sheet 6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

66

New Solutions Think Backward Discussion To get out of this crisis we need actuaries who are able to think different.

Actuaries that can not only analyze ‘numbers’ , but are able to explain how risks and goals can be achieved.

The ability to think backward is essential in this process.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

67

Conclusion Final Conclusions • Limited addition of gold as an asset class in the asset mix: • increases the strength of a diversified portfolio • reduces the downside risk of a portfolio • improves long-term returns of a portfolio • As part of the asset mix Gold offers adequate protection against: • Economic, Crisis and VaR risk • Value fall of other asset classes and international currency • Long-term inflation and negative real interest rates • Gold has a number of important characteristics : • Excellent Collateral (AAA); No counterparty risk • Liquid Transparent pricing; International currency • Best downward volatility protection of all asset classes • Gold should be included in the asset mix.

• Gold is relevant for creating a sustainable pension investment return.

To get there we need to spread knowledge and develop new insights.

6/20/2012

GSCG Market Intelligence – All Rights Reserved

68

Contact, Information GSCG

Jos Berkemeijer : Start-Up Director at GSCG Market Intelligence T: +31 646 12 06 60 E: jos.berkemeijer@gmail.com

Martijn van Eck: Program Manager a.i. at GSCG Market Intelligence T: +31 652 56 87 75 E: vaneck@gscg.nl

6/20/2012

GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

69

Reader Links to Documents Main Documents 1.

2.

3.

4.

Presentatie prof. Dr. Ruud Kleynen (april 2011) congres Visie op Goud WGC:Gold as a strategic asset for European investors (2011, December) The Special Case for Gold (2010) Precious Metals (2011, November)

Specific documents 1.

2.

3.

4.

5.

6.

7.

WCC: Gold: Hedging against tail risk (2010, October) WGC: Gold as a source of collateral (2011, May) WGC: Gold as a Strategic Asset (2006) Safehaven: Going Back to a Gold Standard? (2010) WGC: Gold: alternative investment, foundation asset (2011) WGC: Gold as an asset class (2011, January) WGC: Liquidity in the global gold market (2010)

Internet publications 1.

2.

3.

4.

5.

6/20/2012

Striking Portfolio Balance with Gold Stocks (2011, December) Adding Gold To An Equity Portfolio (2011, October) The role of gold in your investment portfolio (2009) Gold, Silver and Pension Funds Portfolio Diversification Myths (2011, July) USfunds (2011) GSCG Market Intelligence â&#x20AC;&#x201C; All Rights Reserved

70

Reader Titles Relevant Books Studies role of gold in a portfolio

• Thomas M. Idzorek, ‘Portfolio Diversification with Gold, Silver and Platinum’ • Further, Hillier et al, ‘Do Precious Metals Shine: An Investment Perspective’ • Jedrzej P. Bialkowski, Martin T. Bohly, Patrick M. Stephan and Tomasz P. Wisniewski, ‘Is There a Speculative Bubble in the Price of Gold?’

• Dirk G. Baur and Brian M. Lucey, ‘Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold’ • Dirk G. Baur and Thomas K. McDermott, ‘Is Gold a Safe Haven? International Evidence’ • James Ross McCown and John R. Zimmerman, ‘Is Gold a Zero-Beta Asset? Analysis of the Investment Potential of Precious Metals’ • Massimiliano Marzo and Paolo Zagaglia, ‘Gold and the U.S. Dollar: Tales from the Turmoil’ • World Gold Council, ‘Gold as a Source of Collateral’ • World Gold Council, "Gold: Hedging against tail risk"

6/20/2012

GSCG Market Intelligence – All Rights Reserved

71