Gold has been the star performer of 2019, but does the gold rush have further to run? We consider prospects looking ahead.
Over the past few decades, investors have operated with a background of certain assumptions: that governments would put the interests of the economy first, that capitalism was assured and that globalisation was inevitable. Increasingly, those assumptions are being undermined – and as they have evaporated, so has the idea of what constitutes a “safe” asset.
However, there appears to be one investment haven on which investors can agree – gold. In contrast to a relatively pedestrian price gain of just over 2% for the FTSE 100 index over the past 12 months to mid-October, the gold price is up 21%.
Gold mining companies, which tend to offer an accelerated option on the raw material price, are up almost 40% in sterling terms, according to Refinitiv.
The recent strength comes after a wobbly few years for gold, which have seen it struggle to break above $1,350. Its rise coincides neatly with 2019’s falls in US interest rates. This is no coincidence, points out Chris Mahoney, assistant portfolio manager of the Merian Gold & Silver fund. He says that the clearest indication of the likely path of the gold price is the “real yield” on government bonds.
The real yield
The real yield looks at interest rates less inflation. If a government bond has an income of 1%, but inflation sits at 3%, the real yield is negative (-2%). Investors tend to turn to gold when that real yield turns negative.
Mahoney says: “Gold doesn’t pay a coupon or a dividend – therefore it costs investors to own it. This is particularly true if you operate good custody practices and buy insurance.” This opportunity cost is lower when real yields are lower. Gold has also had undoubted appeal as a safe haven in troubled times. The policy U-turn by central banks suggests they do not have full command over the global economic situation. This, alongside an unpredictable White House, the rise of populism, deglobalisation and questions over the future of capitalism itself, have led to a feeling of instability from which gold has certainly benefited.
Gold’s role as a safe haven asset has precedent. It has a robust history of a rising price in troubled times. It rose from $672 to $1,096, for example, during the global financial crisis of 2007/09. It has generally thrived during recessions, notably in the early 1970s and early 2000s. In contrast, it has generally done badly when everything is rosy, when economic conditions are benign, inflation is under control and monetary policy is normal.
The central banks gold-buying spree
George Cheveley, manager of the Investec Global Gold fund, points out that institutional buying has also played a role in pushing up the price. “The fact that central-bank gold-buying is the highest since 1967 underlines the concerns in the market,” he says.
The World Gold Council reported that 19 central banks reported a meaningful increase in their gold reserves in 2018, with total purchases of 651 tonnes, bringing central bank ownership to almost 34,000 tonnes. Poland, Russia and China led the way.
While it is easy with hindsight to see why gold has done well, the question over whether gold represents a good insurance policy today is more difficult to gauge. Bearing in mind its potential weakness during buoyant times, investors either need to be willing to bet on tough times persisting, or risk watching it decline in the expectation that it will work for their portfolio when it is needed.
The future strength of gold price depends significantly on whether the current monetary policy stays in place. Mahoney says: “Interest rates are going to continue to trend lower. The rate-raising cycle from the US Federal Reserve has come to an end and we may be at the start of a multi-year cycle of cutting rates.”
But with interest rates already so low, central banks may not have that much monetary ammunition left, points out Russ Mould, investment director at AJ Bell. Therefore, central banks may return to quantitative easing (QE) and more money creation, in an attempt to avert a recession.
But if this fails, Mould says: “This could tempt investors to look for hard assets, such as precious metals, to protect their wealth, as happened during the early rounds of QE in 2009/11.”
Moreover, central-bank buying is likely to remain in place. Cheveley notes: “Some countries are looking to reduce their US dollar reserves. As a result, we believe the downside to gold prices is fairly limited, with the chance of a move higher more likely.”
For many emerging economies, buying gold is strategic – a way to safeguard the financial security of the country.
Chris Metcalfe, investment director at multi-asset group IBOSS, remains overweight gold across his portfolios. For him, a key part of gold’s appeal is that it performs differently from standard equity and bond markets and thereby brings some diversification to portfolios at a time when that has become tougher to achieve.
He admits there is an argument that a holding in gold presupposes a tougher economic climate, but argues: “If the world is going to end, what use is a gold bar? Surely a Kalashnikov and a tin of beans would be of more use? That said, gold did a great job in the final quarter of 2018 when stock markets were tough. It proved to be a good hedge on central bank policy and systemic risk.” Metcalfe is keeping around 4% of his clients’ assets in gold bullion and gold securities.
His biggest concern is that gold has become so popular. “So many people are piling in,” he notes. However, he is drawn to the precious metal’s useful defensive qualities in tough conditions, although it may be prudent to expect a pullback following its strong performance in 2019.
This, though, is not the only thing to ponder – investors also need to weigh up the various different routes to owning gold as an investment. Those who have room for some gold bars at home (or can pay for third-party storage) can buy the physical metal, or they can buy gold mining shares, a specialist collective fund, or an ETF that tracks either the gold price or an index of gold miners. Each investment option will have slightly different characteristics; the boxout, above, offers some food for thought.
In the current environment, Mahoney is firmly in the shares camp. Not only do gold miners offer geared exposure to the gold price, but they have undergone some major reform.
He says: “In the heady days of 2010/11 with all-time highs for the gold and silver price, discrimination went out of the window. There was a rush for growth. Foolish deals were done and there was a lot of value destruction among gold-mining companies. They have had to rationalise, clean up their balance sheets. As a result, companies are much healthier and debt levels are much lower.”
Cheveley agrees, noting that even if gold prices just remain in their current range, many companies can enjoy good margins and cash flow.
“After years of restructuring and deleveraging, many gold companies are in their strongest position for more than 20 years. At current prices, a number of companies can now look to develop their best projects as well as increase dividends,” he says.
The world’s biggest gold miners tend to be listed on the Toronto or New York stock exchanges and include Newmont Goldcorp and Barrick Gold. London’s biggest gold miner, Randgold, was acquired by Barrick last year, although FTSE 100 silver miner Fresnillo does produce some gold too. Smaller companies include Centamin, Acacia Mining, Highland Gold and Resolute Mining.
Alternative ways to buy the precious metal
If a gold fund or ETF seems a little dull, there are ways to buy gold bullion, including through the Royal Mint. It needs to be stored and insured and may be difficult to sell on, but the Royal Mint offers storage facilities, and if the gold bar no longer serves a purpose, it can be turned into jewellery.
Alternatively, the Royal Mint has unveiled a debit card made from solid gold. Admittedly, the 18-carat card has a big price tag, starting at £18,750 for the basic version, but the owner’s name and signature are engraved into the card. It may not have the long-term investment appeal of an ETF, but imagine the envious stares at the supermarket checkout...
Gold fever or cold shoulder?
Main reason to hold gold: Has proved its value over the years when it comes to protecting portfolios from volatile markets. According to Adrian Ash, director of research at BullionVault, the gold price has risen in eight of the 10 years since 1970 that the FTSE All Share has lost value on a total returns basis, including each of the five years when the index fell by 10% or more.
Main reasons to avoid it: Does not have a yield, nor does it generate cash flow or profit. Instead, its price simply reflects what the next person is prepared to pay for it, so it tends to be volatile.
Fund routes to go for gold: trackers or gold miners
There is a range of specialist active funds that will sift through the gold miners. BlackRock Gold & General is probably the best-known, but other options include Investec Global Gold, Ruffer Gold Fund, Merian Gold & Silver Fund and Smith & Williamson Global Gold and Resources.
There are two main passive options: investors can look to track either the performance of the gold price, or the performance of a basket of gold shares. AJ Bell’s Russ Mould says: “A number of exchange-traded funds (ETFs) and trackers are designed to follow the gold price and provide investors with gold’s performance, minus the fees of running the funds. This spares investors the costs and inconvenience associated with issues such as storage and insurance when it comes to holding physical gold coins or bars, and offers exposure to the gold price. The trackers will move pretty much lockstep with the underlying metal price, although this does mean that they can follow it down as well as up.”
There are trackers that own the physical gold and others that use futures contracts and derivatives instead. ETFS Physical Gold and iShares Physical Gold, for example, own the metal, while ETFS Gold ETC uses derivatives.
For gold miners, there are four ETFs listed on the London Stock Exchange. Three – iShares Gold Producers ETF, L&G Gold Mining ETF and VanEck Vectors Gold Miners ETF – focus on large-cap gold miners (although the iShares and L&G instruments follow the EMIX Global Mining Global Gold benchmark while the VanEck product tracks the NYSE Arca Gold Miners index).
There is also the VanEck Vectors Junior Gold Miners ETF, which provides access to a basket of mid-to-small cap miners, whose share prices are more likely to be volatile as they are more heavily geared to the gold price.
As a rule of thumb it is worth limiting exposure to only a small part of a diversified portfolio. Both the gold spot price and gold funds, which specialise in buying mining businesses, are notoriously volatile.
The chart below– which shows the 10-year performance of BlackRock Gold & General compared to the Investment Association UK Equity Income fund sector average – hammers this point home.
Yellow metal volatility: gold fund vs UK Equity Income sector