Global slowdown fears and trade war risks have sent the gold price soaring, but investors are split on how best to ride the rally.
In August, investors piled $5bn (€4.5bn) into gold-backed exchange traded funds, according to Bloomberg data, and in the onshore mutual fund world gold topped the performance tables for the third consecutive month, according to FE analytics.
The gold price has climbed 17% year to date and was trading at US$1,499/oz on Tuesday.
“The last few years have seen gold dismissed and crypto currencies become the de facto alternative to mainstream currencies – but 2019 has shown you can’t write off the allure of the shiniest metal,” said Ben Yearsley, director, Shore Financial Planning.
“Is it a surprise that US interest rates have started to fall in 2019 and gold has risen? Many observers view this shift has the key driver of the gold price – and not supply and demand.”
Wisdom Tree research director Nitesh Shah said the net long/short position in the gold futures market has never been so high, in sharp contrast to October last year when the position was rock bottom.
Shah added that central banks, particularly in emerging markets, have ramped up buying gold to diversify away from dollar holdings as the US-China trade war continues to rumble on.
‘Abnormal times call for abnormal decisions’
Rathbones head of multi-asset David Coombs said he began increasing his gold position in Q4 2017 for the first time in six years. He said before then gold did not have much appeal because it didn’t generate income, but “abnormal times calls for abnormal decisions”.
“With negative interest rates on various ten-year bonds, you’re actually paying the German, French or Swiss government to lend them money,” he said. “By selling these negative yielding bonds to buy gold, you are sort of increasing your income: the opportunity cost of gold has fallen to its lowest level in decades.”
The movement of interest rates has also driven Coombs’ change in mindset. Over the long term, the price of the shiny metal typically moves in the opposite direction to US interest rates, and with the US Federal now on a rate-cutting path, gold looks attractive, he said.
“When dark economic clouds are poised to open and already-low rates are cut further, investors look to gold for shelter. And that’s what’s happening now. The Fed is creating a supportive environment for gold and we’re buying it,” he said.
Correlations in the gold rally
To illustrate this shift, Psigma Investment Management head of investment strategy Rory McPherson points to the correlation between the value of bonds with a negative yield (white line in chart) and the increase in the price of gold (yellow line).
Gold price versus negatively yielding bonds
Source: Bloomberg
This correlation began to ramp up in tandem in May when trade tensions escalated, and the US Federal Reserve said it was going to start cutting interest rates. This development has pushed bonds into negatively yielding territory which makes the opportunity cost of holding gold much less.
“Gold is a way of sticking your money under the bed,” he adds. “Putting it in something that doesn’t yield anything but does have a tangible value over time makes sense when the alternative is putting money in an asset that you actually have to pay to own.”
Miners versus ETFs
Last October, Psigma was bullish on gold miners because there was record short interest in gold and there had been some M&A activity among mining firms. While Psigma is still positive about gold miners, McPherson said it had taken profits recently because mining stocks have increased about 85% over the last year – and risen about 50% since May.
On top of their stellar performance, owning mining stocks companies frees up capital for other assets, McPherson added.
“We think gold miners are going to rise somewhere between two to three times physical gold this year –gold has risen 17% YTD and miners more than 50%. Therefore, we can own a third of the weighting and have the same effect.
“The corollary of that investment is that if mining stocks head south you get hit much harder.”
Other wealth managers, such as Coombs, prefer to access physical gold through ETFs. The Rathbone Strategic Growth Portfolio currently has a 3.03% exposure to the precious metal through the iShares Physical Gold ETC.
Coombs said from a strategic point of view, gold is a good hedge against disinflation which is a valuable benefit at the moment because he said the market could be heading into a decade of disinflationary headwinds.
“Everyone says gold is a hedge against inflation, which it’s absolutely not. It’s actually a hedge against capital destruction,” he said.
“[Therefore] having spent years arguing the case for every other asset, [these] abnormal times have led us in an abnormal direction and we’re now buying gold as a good store of value.”
Coombs added the escalating global tensions over Iran have provided the “final affirmation as the precious metal can be an effective hedge in times of geopolitical strife.”
Avoiding equity market beta
Shah says accessing gold through an exchange-traded commodity (ETC) provided investors with “pure exposure” to gold, whereas investing via an equity market included exposure to the equities operational risk.
He said: “Equities, regardless of what asset classes they’re operating in, have some equity market beta, so when equity markets are falling gold miners could actually come under pressure as well.”
Many investors have obviously been questioning whether the gold rally can continue. “If trade wars escalate and Brexit negotiations collapse in the coming weeks on top of other political issues in Europe then gold futures could remain high for a protracted period of time,” said Shah.
Under such scenarios, Wisdom Tree’s modelling predicts the gold price could rise to around $1,800/oz. “There is considerably more upside right now,” he added.
The top five Europe-domiciled precious metals funds YTD to end-August have been HANSAwerte (+33.79), AIPM Physical Metals Fund (+30.97%), Global M3 AGmvK Silver Plus Fund (+27.11%), Argentum A (+24.31) and Swisscanto CH Index Precious Metal Fund Gold Physical (+23.84%), according to Morningstar.
Top performing Europe-domiciled precious metals funds YTD
Source: Morningstar
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