The rise of environmental, social and governance (ESG) investing has been nothing short of remarkable and is even starting to enter areas not thought possible a decade ago.

One such area is gold. The benefits of incorporating gold in a multi-asset portfolio are well documented. Over the past four decades, as the price has become more stable, the precious metal has been used as an effective hedge against black swan events.

As a result, assets in gold ETCs have skyrocketed this year with more buyers looking to diversify their risk due to the rapid spread of coronavirus across the globe, however, some of these inflows have come from an unlikely source, ESG investors.

The rationale is simple. With bonds no longer acting as the safe haven of the past due to increasing correlations to equities and debt negative-yielding, multi-asset investors have had to find other ways to improve the risk-return profiles of their funds. One obvious solution, especially in the ETF space where there is a distinct lack of alternative strategies, is gold.

One such wealth manager that has made the move into gold is UK disruptor Nutmeg. The firm’s balanced ESG model portfolio, for example, has a 2.2% weighting to the Invesco Physical Gold ETC (SGLD). In order to avoid calls of greenwashing, the wealth manager has written extensively on the reasons why including gold in an ESG portfolio is justified.

Rumi Mahmood, head of ETF research at Nutmeg, told ETF Stream the regulatory developments in the space and the access to conflict free, responsibly sourced gold has enabled multi-asset investors to make this allocation without the concerns of having a negative ESG impact.

Where Mahmood and other industry participants are quick to point to is the London Bullion Market Association’s (LBMA) Responsible Sourcing programme which came into effect in 2012. The programme requires refiners to engage with producers in defining minimum requirements that are mandatory along the entire precious metal supply chain.

It ensures gold is responsibly sourced and free from any conflict. Hector McNeil, co-founder and co-CEO of HANetf, whose white-label platform helped launch The Royal Mint Physical Gold ETC (RMAU) last year, argued ETCs which are 100% backed by gold bars that meet the LBMA’s standards gives them an ESG stamp of approval.

Responsible sourcing

As a HANetf report said: “Investors who enjoy the diversification benefits of holding gold in their portfolio have long demanded the gold industry to make the necessary strides to provide clarity around the provenance of gold that goes into making the gold bars. The industry met the challenge by implementing a policy around responsibly sourced gold.”

A key point that HANetf and other ETF issuers with newer gold strategies stress is pre-2012 gold cannot be relied upon to be conflict-free as this was before the LBMA introduced its standards.

“Investors are assured that the gold is extracted in a manner that does not cause, support or benefit unlawful armed conflict or contribute to serious human rights abuses or breaches of humanitarian law."

“In contrast, older gold ETFs and ETCs are more likely to hold physical gold that was not responsibly sourced. The older the ETC being held, the more likely it will have bars that do not meet the programme’s strict requirements and their creation and redemption processes do not specify this subset of LBMA ‘good delivery’ bars.”

ESG and SRI factor sensitivities to the business cycle

However, simply because the newer gold ETCs are ‘greener’ and will have higher ESG ratings, does not mean they should be meeting the standards of ESG investors. While the LBMA’s programme has a big focus on ethical sourcing, it does little to address the environmental impact of gold bar production.

This is as much admitted by Nutmeg’s Mahmood who argued the framework is developing and the next iteration of the guidance is expected to relate to the environment. He added that gold has among the lowest greenhouse gas (GHG) emissions per dollar out of the major mined products and its carbon footprint is low as well.

Environmental factors

However, Andrew Limberis, senior associate at Omba Advisory & Investments, was not so forgiving with the view that investments in gold can be sustainable. From a social and governance perspective, the LBMA’s programme goes some way in meeting ESG criteria, however where the precious metal falls down is on environmental factors.

“From an environmental standpoint, there can be no debate on the high cost to the environment, not least due to the high water usage in mining,” Limberis continued. “Any improvement in environmental mining practice is great but improvement does not equal ESG.

“The other factor that works against gold being considered ESG is its fungibility and history. While some gold ETCs avoid gold that was refined pre2012, the gold market is still largely fungible (at least in price). Is owning a gold bar mined and refined in 2018 better than one from 2000 when they both trade at the same price? I am not so sure. That is not to say that gold (and commodity markets in general)
can never rid themselves of their past challenges from an ESG perspective, but the transparency and expectations around responsibly sourcing gold should be significantly improved.”

Meanwhile, Peter Sleep, senior investment manager at 7IM, pointed to the energy-intensive nature of gold product. He said the average cost of producing a gram of gold for the industry is around $1000 per Troy ounce which is approximately the figure for the biggest gold produce Barrick. While there are 31g in a Troy ounce meaning you have to dig up around 15 tonnes of rock which has to be crushed and treated with sulphuric acid to extract the gold.

“The waste is a chemical soup of heavy metals which is put into tailings ponds to evaporate,” Sleep continued. “If we are lucky the tailings dams do not break and pollute the local water supply as happened in say Brazil. Producing gold is a dirty business for something that is essentially a luxury product.”

While the LBMA’s programme is certainly a huge positive for the industry, to say gold ETCs that are exposed entirely to responsibly sourced bars is not enough for it to be labelled ESG. The environmental issues that are still at play do not make gold a true ESG investment and therefore investments in this area can certainly be seen as more greenwashing in a move to improve a portfolio’s risk-return profile rather than justified from an ESG perspective.

This article first appeared in the Q4 2020 edition of Beyond Beta, the world’s only smart beta publication. To receive a full copy, click here.

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