02 August 2019
3 minute read
By Henk Potts, Senior Investment Strategist
After the rally in the gold price this year in a flight to safe-haven assets, what role can the yellow metal play in investors’ portfolios?
Falling global growth forecasts, ongoing geopolitical tensions and aggressive policy easing expectations have investors queuing up to buy gold.
Recent months have seen the rally in the gold price extend. In May, we saw the biggest monthly increase since 2016, pushing the price of gold up to its highest level since April 2013. Currently trading around the $1400 an ounce level, gold is up close to 11% year to date. However, this is still significantly below the $1920 all-time high achieved in September 2011.
The radical pivot in US interest rate expectations seen in recent months has also had a significant impact on the price of gold. A lower policy path reduces the opportunity cost of holding a zero interest bearing asset. Lower interest rates can also weaken the dollar, so reducing the costs for non-dollar dominated buyers.
In May, we saw the biggest monthly increase since 2016, pushing the price of gold up to its highest level since April 2013.
Investors that are apprehensive about the economic outlook primarily gain exposure to gold through exchange traded funds (ETFs). Gold ETFs are a more efficient way to hold gold when compared to buying bars and coins after the costs of buying, storing and insuring physical gold is taken into account. Flows into gold ETFs have climbed this year. According to Bloomberg data, three million ounces were added in the first half of this year, with the total gold held by ETFs up 4.2%.
Two decades ago, Gordon Brown, the then British Chancellor of the Exchequer, decided to sell just over half of Britain’s gold reserves. The controversial move was executed at an average price of $275 an ounce. It is estimated that the decision cost the taxpayer as much as £5bn, although it’s hard to quantify the exact loss/gain given we don’t know how the proceeds were invested.
While the Labour government were cautious about the precious metal’s long-term prospects, there are a wide range of governments that are still willing to increase their holdings. World Gold Council figures show central bank purchases rose 74% in 2018 compared to 2017. Central banks added 651 tonnes last year, which was the most since 1971.
Leading purchasers include Russia, Turkey and Kazakhstan. A range of factors are proffered for the surge in purchases including “dedollarising reserves”, reducing counterparty risk and diversifying holdings.
Central bank purchases [of gold] rose 74% in 2018 compared to 2017.
Rising demand from investors has helped to overshadow the relatively lacklustre demand for gold used in jewellery. Global gold jewellery demand only rose 1% in the first quarter of 2019 on a year-on-year (y/y) basis. The slowdown in growth and rising trade tensions held back Chinese buyers. Political and economic disruption in Europe and currency weakness in Turkey and Iran also cut demand. On the positive side, wedding purchases and lower prices boosted Indian demand (+5% y/y) while the US only registered minimal growth.
Global gold jewellery demand only rose 1% in the first quarter of 2019 on a year-on-year (y/y) basis.
Industrial demand is subsidiary to the role of jewellery in determining the total demand for gold. With gold being a very efficient conductor, not tarnishing and able to be melted down, it is valuable to the electronics industry.
Gold is used in a range of devices including smartphones, global positioning systems and televisions. While the quantities per device are very small, the aggregated volume used is still worth monitoring. The recent slowdown in hardware sales, due to the slower replacement cycle, has held back demand growth.
Furthermore, demand from the dentistry industry, a traditional user of gold, has been in structural decline over the past decade as the industry adopts alternative materials including all ceramic crowns.
While jewellery and industrial demand growth has been limited, supply has steadily been rising. Mine production rose to record level last year, driven by new projects coming on line and state supported expansion. Rising recycling has also boosted the supply of gold, particularly from the distressed economies of Iran and Turkey.
Investors are attracted to gold for a multitude of different reasons. Rightly or wrongly, gold is seen as a safe-haven asset. There’s no fundamental reason why this should be the case, but if enough people believe it, it starts to generate its own truth.
Gold is also seen as a hedge against inflation. Data suggests gold hasn’t done a great job as a store of value over the past few years. However, over longer periods of time, such as the past century, it has been a useful tool.
Most importantly for us, we think that gold should be used as a diversification tool, as demonstrated through our Discretionary Portfolio Management asset allocation model. For the majority of our clients, the allocation to gold should be in the low single-digit percentage range. Clients trust us to preserve and grow their wealth. Gold can be used to preserve portfolios during turbulent times, but is unlikely to be the source of growth over prolonged periods of time.
For the majority of our clients, the allocation to gold should be in the low single-digit percentage range.
Find out our latest key investment themes. As expectations of more dovish central bank policy grow and early signs of a potential thaw in trade tensions, sentiment has turned for the better. However, with many geopolitical issues on the horizon and several financial markets close to record highs, is it time to de-risk portfolios?
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