Gold is less volatile than major Islamic equity indices, REITs and the takaful index. While it is more volatile than sukuk, it is a safer asset class because it carries no credit risk or third-party liability. Gold also outperforms other Islamic asset classes.
Gold’s distinctive behaviour as a financial asset makes it an excellent risk management tool as well. This is particularly significant for Islamic investors, who cannot use derivative-based risk-management instruments such as credit default swaps, futures, or forwards. Given that gold functions as an effective hedge against foreign exchange risk, tail risk events and other types of disruptive market fluctuations, its inclusion as a Shariah-compliant asset will give Islamic investors a robust new tool to protect their investment positions.
Gold’s role as a preserver of wealth may be particularly significant in Islamic finance. Gulf-based investors generally hold their positions denominated in US dollars or in a currency pegged to the dollar. However, Southeast Asia-based investors generally denominate their positions in local currency, typically Malaysian ringgit or Indonesian rupiah. These currencies have a historical tendency to fluctuate against G10 currencies, and to underperform during periods of acute market instability. Adding gold to a ringgit- or rupiah-denominated investment portfolio can greatly moderate exchange rate risk.
For more information on the investment case for gold in Islamic Finance, read our full report.
Four critical roles that gold can play
The launch of the Shari’ah Standard on Gold will not simply facilitate more Shari’ah-compliant investment; it can open up an entire asset class to the Islamic finance community. As such, it can help to shape the future of Islamic finance.
Gold is a powerful investment tool that can benefit Islamic investors:
Gold’s distinctive qualities as a diversifier, risk management tool and long-term preserver of wealth mean that it fills critical missing links in the current array of options available to Islamic investors. Virtually any Islamic portfolio can be improved through some allocation to gold, implying that gold can boost returns for every class of Islamic investor. In essence, this asset class is a Pareto improvement to Islamic finance.
Gold significantly enhances the Islamic investment universe:
Islamic finance currently lacks a true safe haven asset. Fund flows during times of acute market stress may cause price dislocation and liquidity shocks. Current low risk Islamic assets are either too limited in size or too illiquid. The addition of gold will provide Islamic investors with a vast, safe asset class that is highly accessible in times of need. This will help to reduce systemic risk in Islamic finance, making the market safer and smoother for all investors.
Gold can power the next stage of Islamic finance’s development:
The inclusion of gold as a Shariah-compliant asset opens up an entirely new asset class, allowing for new opportunities to innovate and expand.
A distinctive asset in a distinctive market:
Gold is a distinctive asset. Through the centuries, gold has motivated civilisations to aim higher and strive harder. It has ushered in scientific advances while also sparking artistic genius. Gold is not simply a unique financial asset; it is an integral and inspiring component of the human story. It is perhaps fitting therefore that this most ancient of elements is now able to power the future of Islamic finance.