Gold and the merits of holding the shimmering commodity in a diversified portfolio.
Keeping your capital golden
Mr Morgan went on to explain to Congress in December 1912 that credit is an evidence of banking, but credit is not the money itself. Money is gold, and nothing else.
Past performance is no guide to the future however, it is a good starting point to understand possibilities. In this month’s piece I am going to look at why holding some gold in a portfolio now might have its merits in the future.
The past a guide to the future
As a child of the seventies I can remember some unforgettable moments, most of them centred around popular culture: such as anything with John Travolta in it, arcade games, Happy Days, Jaws, Charlie’s Angels, Star Wars and Atari games console. What I seem not to remember, and I’m sure I am not alone in this is a decade of stock market volatility, flat returns from stocks, oil price shocks, political instability and central bank policy that led to stagnant economic growth. Probably because I was only 6 by the end of the decade!
While the market parallels are not like for like, similarities do exist. And they are sufficient to give us a guide to base an understanding of the direction of asset prices ahead.
Below is a graph currently doing the rounds that seeks to draw parallels of gold prices in these two periods – the start of the 1970s, which saw Nixon abandon the gold standard to 1980 and from the Financial crisis in 2008 to the present day.
The left circle represents Nixon abandoning the gold standard and the subsequent rise, correction and further rise over the decade. The right circle represents the start of QE and the subsequent rise of gold, correction. If history were to repeat itself, we would expect to see the start of another period of significantly rising gold price.
Inflation adjusted gold graph
To add some additional weight to the idea gold could go higher from here I have included the graph below. Now I’m not much for technical analysis however, I do understand that there has been a clear pattern of higher lows in recent times, as depicted by the curves on the graph below. On the same graph it can be seen that gold also broke out of a wedge pattern in late 2017. This information could be highlighting a new floor in the gold price. Gold has seen a pickup in demand in 2017 - notably in China and India where imports rose by 40% and 67% respectively. Gold production was soft in 2017, which would be supportive of tighter supply helping to lift prices too.
The US Dollar
Of course a strong US dollar would be a headwind to the gold price rising, there are though some factors which could challenge the dollar’s recent strength. Namely a drawn out trade war, tax reform resulting in an increased fiscal deficit, the potential for central banks to diversify away from dollars, China allowing the renminbi to fall or Donald Trump finally shifting investors’ confidence in the US’s reliability on the world stage. While these factors alone, or a mixture, could lead to a weaker dollar there are a number of factors that could equally see it strengthen.
The US is now in a rising rate environment, which in part is a result of better more sustainable economic growth but also as a consequence of China and Japan, the two largest purchaser of US debt, scaling back purchases. This has led to falling demand at a time when supply is rising. This is also putting pressure on the FED to raise rates and once more make its money look more attractive to overseas investors.
While rising rates is not such a bad thing, after all it indicates that the economy is growing, it will increase what the US government pays as interest on its debt. US debt outstanding currently stands around $17 trillion and is rising all the time. Why is this important? Well if we go back to J.P. Morgan’s response to congress and the notion debt is a fiat currency, gold becomes a hedge against a loss of confidence in the system.
Inflation is an important consideration when looking at gold, as gold is normally used as a hedge against inflation. Conditions that represent inflation are rising property prices, rising stock market, rising asset values. Higher inflation is normally a consequence of higher debt burdens. To lower prices there is normally a period of deleveraging. What’s interesting is that we know since QE that asset prices have been on the rise, exemplified by an almost 10 year bull market in equities. What has been missing is inflation of any note.
Is inflation on its way back? In May the US saw headline inflation of 2.8%, the highest since February 2012. Many of the factors covered in this article could trigger higher inflation from here.
Regardless of whether you are a gold bug and you believe any of the factors covered play out, gold should have a place in a diversified portfolio as it tends to respond positively to events that cause the value of fixed income and equity to fall. Over the long-term gold has maintained its purchasing power despite short-term volatility. As Ned Naylor-Leyland, the manager of the Old Mutual Gold and Silver fund said to me recently, ‘you wouldn’t put a football team out without a goal keeper!’ referring to gold representing a small yet important part of a well-diversified portfolio. A back-stop should all else fail.
Gold moves independently of stocks and bonds and over the long-term should protect your purchasing power.
For investors looking for a safe haven asset in case conventional currencies lose their value because of another financial crisis, higher inflation or political instabilities they need to beware there is a level of risk. Despite gold being deemed as a safe haven asset, it is still very volatile as sentiment of global financial conditions can change very quickly. Investors must be prepared to accept the volatility and higher risk associated with it.
What we can be certain of
There is a finite amount of gold in the world with considerably more above ground than below it, c190,000 metric tons to 54,000 metric tons respectively. It can’t deplete naturally and it can’t be produced in a laboratory. This provides a level of certainty that the price is a balance between supply and demand with its physicality giving it its intrinsic value.
Gold is a tangible asset that has been money for 5,000 years, whereas currencies and credit are money substitutes, liabilities of banks. Gold is unique and has been an important factor in the development of civilisation. Other tangible assets fail to meet all the special attributes gold exemplifies as money, gold doesn’t deteriorate, get used up, deplete or worn out, while all gold ever mined throughout time still exists.
Funds and an Exchange Traded Commodity (ETC) you may want to consider:
Gold & Silver equities and physical gold & silver ETCs
Old Mutual Gold and Silver invests in both the physical metals of gold and silver and the mining equities. The manager aims to deliver 2-5 times the return of gold in a bull market and match the return of gold in a bear market.
Gold equities with the possible use of ETCs
Investec Global Gold invests in companies that are exposed to gold mining and which tend to have a higher degree of liquidity than investing directly in the physical product itself.
ETFs may also be used in the fund where deemed appropriate. Gaining exposure to gold via a fund means that your returns are not only reliant on demand for the asset but also the management of the company mining and/or managing the raw material.
Exchange Traded Commodity (ETC)
Source Physical Markets Gold ETC aims to provide the performance of the spot price of gold through certificates collateralised with gold bullion which is held in J.P. Morgan Chase Bank's London vaults. The vast majority of the gold bullion collateral is held in allocated gold bars.
Our multi-manager funds have a holding in these investments. Read more about our multi-manager fund range.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.