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Ruffer: Two reasons why gold is back in our good books

29 April 2015

The precious metal has had a miserable time of late, but Ruffer says it is more attractive than it has been for some time.

By Joshua Ausden,

Head of FE Trustnet Content

A likely reversal in the strength of the rallying US dollar could see gold come into its own again, according to Ruffer’s Steve Russell, who is poised to increase his allocation to the yellow metal.

Gold was a star performer in the immediate aftermath of the financial crisis, rallying from around $750 per troy ounce in 2009 to over $1,900 in September 2011. The debasement of paper currencies via quantitative easing, stubbornly high inflation and concerns over a break-up in the eurozone were major drivers for the “safe haven” metal.

Since then, gold has struggled. Currencies, and the US dollar in particular, have since recovered, the global economic recovery has gathered pace and inflation is falling all over the world. FE data shows the price of gold has fallen by 33.53 per cent from the 2011 peak to around $1,200 at time of writing.

Performance of index over 8yrs

 

Source: FE Analytics

Many managers have been caught out by the fall, proving particularly painful for naturally defensive funds such as CF Ruffer Total Return and Troy Trojan, which view a permanent loss of capital as their number one enemy. Both Ruffer’s Russell and Troy’s Sebastian Lyon have viewed the yellow metal as a hedge against inflation and deflation, and a general hedge against economic instability.

The £3.14bn Ruffer fund holds gold principally as an inflation hedge. Russell and co-manager David Ballance believe high levels of inflation will be the natural result of central banks’ loose monetary policy, which wants more than anything else to inflate away their economies’ debt burdens.

CF Ruffer Total Return has 6 per cent in gold and gold equities, but Russell says he is tempted to up his exposure for two reasons.

First off, he believes the gold price could be set to spike.

“Gold is our safe haven asset against inflation and deflation, and also a protector against the sickness of paper currencies,” he said in an exclusive interview with FE Trustnet.

“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.”

Performance of currencies versus sterling over 1yr

 

Source: FE Analytics

“We’ve got 6 per cent at the moment and we’re happy with that, but we could go up to 10 per cent.”


 

Secondly, Russell says gold is automatically more attractive because his preferred methods of protecting against inflation are less attractive than they were.

“We’ve been loaded up in inflation-linked bonds which are a better source of inflation protection. This has absolutely been the right thing to do, but they’ve performed very strongly recently which has also increased the attractiveness of gold as an asset,” he said.

“We have cut back our US long-dated from 5 to 2.5 per cent. The rest of our exposure is via shorter-dated bonds, which has had less of a surge and is generally less volatile.”

Performance of indices over 1yr

 

Source: FE Analytics

Index-linked government bonds remain Russell’s biggest weighting, however, at around 30 per cent in total and Russell says he expects long-dated linkers to remain an important feature of the portfolio for some time.

“Shorter-dated bonds don’t give you the same kind of protection against inflation. We envisage that the price of long-dated bonds could double from here in light of a much higher rate of inflation,” he said.

“Linkers have had a very good time of it in the short term, but we are committed to keeping 10 per cent of our UK long-dated inflation-linked bonds because of the threat we see.”

 

Inflation is next to 0 per cent in both the US and UK, thanks in part to a plunging oil price. Inflation protection is the last thing many investors are thinking about at the moment, but Ruffer’s resolve is stronger than ever.

“The need to protect against the threat of rising inflation is just as important now as it has been for the last seven years, even though I am very aware that inflation is close to 0 per cent in the UK at present,” Russell said.

“From our point of view, the fact that there has been so much focus placed on deflation further supports our base case, as it is likely to increase reflationary policies. Inflation falling to zero has resulted in very slight positive interest rates and central banks are all too aware that the debt burden is actually now increasing.”

“The ECB have reacted to this with QE with the aim of driving down yields and the Fed is suddenly now talking about a wage inflation target.”


 

While QE is no longer ongoing in the US and the UK, Russell expects a different form of stimulus to ensue in the coming months and years.

“The key thing here is the credibility or lack of credibility of central banks,” he argued. “Quantitative easing has worked in the respect that the financial system didn’t collapse and asset prices have risen. However, it has so far not done enough to force through a real economic recovery.”

“Interest rates are at 0 per cent and the debt is still there and as a result I think we’ll see more targeted fiscal and monetary policy from hereon in, most likely in the form of tax cuts and infrastructure spending. This will push more money into the economy which is of course needed, but inflation will be a by-product.”

Russell argues that the central banks’ need to get inflation going combined with the difficulty of the task has increased the likelihood of a major policy mistake, thus increasing the need for inflation protection.

He commented: “The problem is that it’s very hard to get a little bit of inflation, which we’ve seen in Europe, the UK, the US and Japan.”

“It’s remarkably difficult to get it from 0 to 2 per cent, and given how difficult it’s been so far to hit even a mild target I think some central banks will be using a sledgehammer. This increases the likelihood of a policy mistake.”

Russell is all too aware that Ruffer has been talking about high levels of inflation for some time – this interview with FE Trustnet dates back to August 2012. 

However, he points out the team were also early when they predicted a debt-fuelled crisis back in 2005 and 2006. CF Ruffer Total Return was one of the few funds that actually made money in the crash year of 2008, delivering over 20 per cent to investors. This has been the main driver of the fund’s top decile performance in the IA Mixed Investment 20-60% sector over the past decade.

Russell isn’t the only one who thinks inflation is on the cards; Invesco’s Martin Walker expressed similar concerns in an interview with FE Trustnet earlier this week. 

In two previous articles, Russell discussed his bullish views on Japan and his concerns over UK Equity Income valuations.

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