Should investors hang onto their pots of gold?

No

Chloé Koos Dunand

Commodities strategist, Pictet Wealth Management

Chloé Koos Dunand, Pictet

Back in July 2013 when the bullion price was levelling out at $1,200 (€868) an ounce after plummeting by almost 25 per cent in three months, Ben Bernanke, then Fed Chairman, admitted to the US Congress that “nobody really understands gold prices and I don’t pretend to understand them either”.

Without doubt, the slump in the gold price is bemusing when seen in context. Several leading economic indicators, like the Purchasing Managers’ Indexes (PMI), were still in the red zone at that time; the ECB had just cut interest rates; the UK had been shorn of its triple-A credit rating; China was expanding at below 7 per cent; central banks in many countries were still printing money a-go-go.

Financial investment is the main force driving demand for gold in times of crisis and, as gold cannot be valued using the same sort of yardsticks as for bonds or equities, the price of gold tends primarily to reflect investors’ confidence in the state of the global economy and financial markets. Midway through 2013, a move to pull investments out of gold looked premature. Admittedly, the global economic picture had been looking somewhat brighter in preceding months, but the outlook was still very unsettled and the prospects for recovery hung in the balance.

Consequently, as whenever there are suspicions a decision may have been swayed by emotions, the key is to gauge whether the slide in the gold price was genuinely warranted and whether it could tumble even further or, conversely, stage a rebound.

The main arguments for investing in gold have become considerably less compelling, but one more weighty factor has recently been added to the list of gold’s ‘cons’ – the opportunity cost of owning gold. As gold does not provide investors with a guaranteed return, it becomes a competitive option when interest rates are close to zero. As soon as economies regain enough momentum to prompt rises in interest rates, be that at the short- or long-dated end of the curve, the opportunity of owning gold climbs.

Today, US long-bond yields are pitched close to 3 per cent a year, and the Reserve Bank of New Zealand has been the first central bank in a developed economy to hike its interest rates, with some 75-100 basis points more expected, which could possibly push the target interest rate up to 4 per cent before the year-end. The more the global economy improves, the more gold will be confronted by this type of competition.

The chief counter-cyclical arguments for owning gold have been diminishing as the global economy regains momentum. Demand for safe-haven assets has been on a downward trend, and the cost of buying such insurance has been rising. Looking at the pro-cyclical arguments for investing in gold (demand for jewellery and from industry), they do not really carry enough weight to push the gold price upwards. At best, they provide a base-level of support for the price, rather as central banks’ purchases do.

Gold mainly reacts to the ebbs and flows of risk aversion on financial markets, and events in the opening part of this year have demonstrated yet again it would be wrong to sound the death-knell for gold. Although short-term prospects are hard to assess because the situation is still instable, turning towards the longer-term horizon, the outlook for gold is bearish.

There are no signs of rampant inflation, yields are rising worldwide, the consensus is positioning itself for a stronger dollar, the US is expected to post strong GDP growth this year, and the new Fed Chair Janet Yellen has surprised markets with hawkish monetary-policy forecasts.

These rational considerations lead to the conclusion that gold is definitely losing its lustre. As a crisis draws to a close, the good news for the world is usually bad news for gold, which suggests to us that gold no longer warrants its place as a must-have component in portfolios. 

Yes

Ani Markova

Co-manager of Smith & Williamson Investment Management’s Global Gold and Resources Fund

Ani Markova, Smith & Williamson

In today’s world of abundant investment opportunities such as equities, bonds and complex derivatives, gold remains a unique tool for wealth preservation in our geopolitically complex and financially unstable global economy.

Due to its physical characteristics and historic role as money, reserve asset and status metal, gold is an attractive asset and investment with a value that does not move in step with other asset classes, such as highly correlated equity markets. Gold prices also tend to move higher during periods of low or negative real interest rates and rising inflation expectations, which makes it a desired hedge in environments of systemic stress.

Due to its ‘safe haven status’, studies of historical price patterns show gold prices tend to respond positively during geopolitical crises, delivering returns in the order of 5-10 per cent. If a portfolio had allocated 5 per cent to gold, it would have outperformed by 735 basis points over tail-risk events that include Black Monday, the Long-Term Capital Management crisis, September 11th, the 2002 recession, the 2008 recession and the sovereign debt crisis, according to estimates by the World Gold Council.

Given that geopolitical crises are difficult to predict and economic implications of such disruptions are hard to estimate, gold could be considered insurance against such disruptions, especially considering deteriorating stability in the Balkans, Middle East and South-East Asia.

Corrections along the way create buying opportunities, as gold tends to go through periods when different factors have a dominant influence on supply and demand characteristics and pricing. Last year, short-term focused investors that held gold in ETFs and other gold investments liquidated 881 tonnes in a frenzy to take advantage of rising US equity markets, causing a 31 per cent contraction of the gold price and a 54 per cent deterioration of the S&P/TSX Global Gold Index (both in euro terms), according to Thomson Reuters Datastream.

Despite this, physical demand for bar, coin and jewellery reached a record high of 3,864 tonnes in 2013, according to the World Gold Council. China, India and central banks around the world purchased 2,460 tonnes of gold in 2013, just over 80 per cent of global mine production. If these steady accumulators continue to demand physical gold at these rates, investors will need to compete for a limited availability of bullion.

Gold equities should also stand to benefit from these solid demand trends. During the early stages of gold rallies, gold stocks tend to outperform bullion on the back of significant cash flow increases from small changes to the gold price. For example, in the first quarter of 2014, the bullion price rallied by only 6.7 per cent vs the S&P/TSX Global Gold Index (a broad measure of gold equity strength), which gained 11.3 per cent after three years of underperforming bullion.

Gold’s inelastic supply and mine reserves of only 12 years at current prices imply scarcity should start to be priced in over the next few years. In spite of short-term price fluctuations brought about by a stronger US dollar, gold has remained a viable long-term investable asset class. In an overleveraged world subject to currency wars and geopolitical conflicts, with only 1 per cent of global financial assets invested in gold, we see a pent-up demand for the precious metal to preserve wealth.