The role of gold in Islamic finance

The AAOIFI Shariah Standard on Gold developed in collaboration with the World Gold Council was a game-changer for the role of gold in Islamic finance. For the first time, the world’s leading Islamic scholars issued a collective Fatwa on the trading of gold, clarifying the transactions that are permitted and enabling the development of new and innovative gold-backed products. Since its launch, new products have been developed including exchange-traded funds (ETFs) and gold investment accounts, enabling consumers across the Islamic world to benefit from the wealth preservation properties of gold. ANDREW NAYLOR writes.

Why is gold an attractive Shariah compliant asset class?
Gold has long been valued for its distinctive investment benefits. Although gold is no longer the basis of the international monetary system, its status as a pillar of stability persists, a role which has become ever more important in today’s uncertain economic environment. Dr Hamed Hassen Merah, the former secretary-general of AAOIFI, said: “Gold has motivated civilizations through the centuries to aim higher and strive harder. Gold is more than just a financial asset; it is an integral component of human life”.

Over the years, gold’s reputation for safety and stability has made it a mainstay for investors seeking to preserve their wealth, not least central banks around the world which consider gold to be the ultimate wealth preservation tool. New investors, such as pension funds, institutional investors and family offices recognize the benefits of gold.

The reasons for this are clear:

  • Gold is a well-established, deep and liquid asset – the market of financial gold is over US$3.5 trillion, larger than all other Shariah compliant asset classes combined.
  • Gold is an effective diversifier. It exhibits little or no correlation to other asset classes in Islamic finance. This makes it a powerful diversification tool. This is even more important in Islamic finance where the breadth of available assets is smaller.
  • Safety – gold has no default risk and performs well in times of crises. It is the ultimate Shariah compliant safe haven asset.
  • Gold provides returns. Including gold in an Islamic portfolio can reduce volatility and help mitigate risks.
Chart 1: Gold is a large and liquid market
Asset class Size of market (2017) (US$ billion)
Financial gold 3,500
Islamic banking assets 1,600
Sukuk outstanding 400
Islamic funds assets 67
Takaful contributions 26

Sources: World Gold Council, IFSB

The gold market is larger and more liquid than other Islamic assets. At a current market size of US$3.5 trillion, gold is one of the world’s largest and most liquid asset classes. The financial gold market is over twice the size of global Islamic banking assets and is almost nine times larger than the current volume of outstanding Sukuk.

Gold is a powerful diversifier because it has virtually no correlation to major Islamic asset classes. A result of +1 or -1 implies perfect positive or negative correlation, with 0 implying no correlation at all. As our analysis shows, gold’s correlation with major Islamic asset classes ranges from only 0.14 to -0.03, implying almost no correlation in performance. This lack of correlation makes gold a powerful diversification tool for Shariah-conscious investors.

Over the last century, gold has vastly outperformed all major world currencies. For Islamic investors, gold’s role as a preserver of wealth can take on a more pronounced role. Gulf-based investors generally hold positions denominated in US dollars or in a currency pegged to the dollar. Southeast Asia-based investors generally denominate their positions in local currency, typically Malaysian ringgit or Indonesian rupiah.

Consumer views on gold in Islamic finance
The main reasons why gold is an attractive asset class in Islamic finance are clear and well-understood. However, a survey was needed to better understand consumer perceptions of gold as a Shariah compliant asset. That is why the World Gold Council commissioned market research in key Islamic markets: Malaysia, the UAE, Saudi Arabia and Turkey. Qualitative and quantitative research was conducted with 1,000 investors completing a 20-minute survey in each market.

The outlook for Islamic finance is positive – across all markets in the survey a majority of respondents are planning to start investing in Islamic products, or increase their current investments in Islamic products in the next 12 months. Consumers hold a range of gold products, and the outlook for these products is strong.

     

Conclusion
The results of the research show that the outlook for gold and Islamic finance is very positive. A key attraction of gold is its Shariah compliance and investors are interested in a range of gold products, including bars and coins, gold investment accounts and gold-backed-ETFs. These products meet different financial needs, but most consumers that we surveyed believe that investing in gold can protect their wealth and generate long-term returns.

Andrew Naylor is the director of central banks and public policy at the World Gold Council