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Gold is now more important than ever, says Sebastian Lyon

18 May 2015

Gold has been one of the most hated assets over recent years, but star manager Sebastian Lyon is betting on the precious metal to rebound.

By Alex Paget,

Senior Reporter, FE Trustnet

The race by the world’s central banks to debase their currencies means holding gold bullion is vitally important in the current environment, according to star manager Sebastian Lyon, chief executive at Troy Asset Management.

Lyon, who heads up the highly popular Troy Trojan fund and Personal Assets Trust, recently told FE Trustnet that investors face the “particularly unpleasant” combination of very low returns and high volatility as years of extraordinary central bank monetary policy have left nearly all assets classes expensive and therefore highly correlated.

However, one area of the market the manager is optimistic on is gold bullion – which accounts for 11 per cent of his open-ended fund and 10 per cent of his trust.

Though the price of gold has fallen considerably since its peak in 2011 to its current level of $1,225, Lyon thinks it will start to become highly sought after as central banks’ total assets, as a percentage of GDP, continue to increase.

“Personal Assets is not a gold fund, although it has been accused of being one. But we have held gold going back to 2005 both as insurance against financial distortions but also as insurance against currency debasement,” Lyon (pictured), speaking at the Cantor Fitzgerald "Opportunities in Multi Asset Investing" seminar, said.

“We have talked about this relay race to debase. Clearly, the euro and the yen are at the vanguard at the moment but prior to that it had been sterling and the US dollar. The reason to hold gold is because we feel this race to debase is, if anything, likely to pick up speed and will not be reversed.”

Central banks, such as the US Federal Reserve, Bank of England, Bank of Japan and the European Central Bank have all tried to devalue their currencies over recent years in order to reflate their economies and reduce the cost of their debt.

As the graph below shows, thanks to unprecedented levels of money-printing in Japan and full-blown sovereign quantitative easing in the eurozone, the euro and the yen have depreciated by a huge amount relative to the US dollar over recent years.

Relative performance of currencies over 3yrs

 

Source: FE Analytics

Lyon added: “Ultimately, portfolios need some form of protection from this central bank unorthodoxy.”

Gold had been the go-to asset for investors in the years building up to and immediately after the financial crisis.

According to FE Analytics, the price of the precious metal soared by 544.47 per cent between January 2000 and September 2011, eclipsing the returns from both bonds and equities in the process.

As the graph below shows, the real gains were made from gold around the time of the crash in 2008 and in its aftermath as investors became more and more concerned about the state of the global financial system and therefore yearned for its ‘safe-haven’ characteristics.

Performance of indices between Jan 2000 and Sep 2011

 

Source: FE Analytics


 

However, since then gold bullion has fallen a hefty 32.44 per cent while bonds are up 17.85 per cent and equities have gained more than 60 per cent.

Performance of indices since Sep 2011

 

Source: FE Analytics

A number of explanations have been given for this. Firstly, despite central bankers’ best efforts, inflation has stayed stubbornly low. Also, improving economic data and roaring financial markets have meant investors have felt increasingly confident taking more risk in their portfolios.

Finally, with ultra-low interest rates, any asset which doesn’t offer income has been largely ignored by investors. This has especially been the case with gold, given that its price is purely driven by what a buyer would pay for it.

Nevertheless, while the fall in the gold price has weighed on his performance, Lyon thinks all the negative sentiment towards the precious metal is about to change as central banks continue to inject liquidity into the market.

“We are in the midst of a huge experiment in monetary policy and no one knows how it is likely to end,” he said.

“We see that line [central banks’ assets] ultimately increasing and we would expect gold, having had a major correction since 2012, to come back in favour as investors will want that insurance once more.”

“That is particularly the case when the opportunity cost of holding cash, which has been one of the reasons not to hold gold, is no longer there. In fact, you will make more money in gold than you would in a Swiss or Danish bank account today because of nominal negative rates – so that argument is no longer with us.”

Lyon has long been bearish on financial markets and his defensive positioning, such as his high weighting to gold bullion, has hindered his returns over recent years. As a result, he has come under criticism from parts of the industry for being too unwavering in his views.

Our data shows, for example, that both his fund and trust have underperformed against their FTSE All Share benchmark, which is up 109.84 per cent, by more than 45 percentage points over the last six years.

Performance of fund and trust versus index over 6yrs

 

Source: FE Analytics

However, Lyon has built up a loyal band of investors due to his longer term track record.


 

According to FE Analytics, his £2.5bn Trojan fund is the second best performer in the IA Flexible Investment sector since its launch in May 2001 with returns of 180.04 per cent, beating the FTSE All Share by 66.04 percentage points in the process.

Performance of fund versus sector and index since May 2001

 

Source: FE Analytics

It has also had the lowest maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – since launch at just 9.81 per cent, which is around five times lower than that of its benchmark.

That is because the fund has come into its own in falling markets. FE data shows it made a slight 1 per cent gain in 2008 when the index fell 30 per cent and returns of 8 per cent in 2011 when the FTSE All Share lost 3.46 per cent.

Lyon isn’t alone in talking up the prospect for gold, though, as FE Alpha Manager Steve Russell also told FE Trustnet it is more attractive than it has been for some time and is therefore looking to increase his exposure.

“Gold is our safe-haven asset against inflation and deflation, and also a protector against the sickness of paper currencies,” the Ruffer manager said earlier this month.

“Over the last year the dollar has been in the ascendency so gold hasn’t been called upon. It’s only really been that and the renminbi that’s strengthened, but were either of those to reverse I think we could really see gold come into its own.”

However, while the team at Whitechurch Securities understand the reasoning behind holding gold in the current environment, they say investors can still find better opportunities.

“Even though we can appreciate investors holding gold as an alternative to cash or as a diversifier, we continue to be wary of gold exposure,” Whitchurch said. “However, if the dollar continues to weaken and bond yields remain low it could return to favour with investors as a ‘store of value’.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.