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Why gold will continue to outperform equities

27 August 2016

With gold rallying around a quarter so far this year, Fidelity’s Nick Peters looks at whether there is still a case to buy the precious metal.

By Jonathan Jones,

Reporter, FE Trustnet

Gold remains a solid addition to any portfolio as a safe-haven hedge, according to Nick Peters, portfolio manager at Fidelity Multi Asset, who has added positions in two of his multi asset total return funds recently. 

Five years ago this week, the gold price hit its record high of $1,900 but the metal has taken a hammering since, falling to lows of $1,000 by the start of this year.

While many analysts predicted further falls, with some worried that the yellow metal could drop as low as $800, like those that predicted the oil price could fall below $10 per barrel – they were wrong.

Performance of gold price over five years

 

Source: FE Analytics

Gold hit a low of $1,061 at the start of this year, but has rebounded strongly, rising more than a quarter (26.71 per cent) since 1 January.

While this is still some way from the highs seen five years ago, it is an encouraging sign for the precious metal, and Peters said: “Many investors have looked to add to gold on the back of fears over global growth, with worries over a slowdown in China particularly prevalent at the beginning of the year.”

With the prospect of a slowdown in China and the fear that central banks are running out of firepower, investors looked to add gold as it traditionally works as a safe-haven in times of economic uncertainty, providing a hedge to market volatility.

“The impact of these fears can be seen on the gold price over 2016, with a sharp leg up occurring at the height of market panic in the second half of January.”

However, he says, the precious metal has benefitted from a lot more than just investor sentiment, with an easing of headwinds also contributing to gold’s resurgence.

“The Federal Reserve’s (Fed) adoption of a more dovish stance at the beginning of the year resulted in an easing of the strong dollar trend, normally a headwind to the gold price.”



Gold is traditionally valued in dollars, meaning when the dollar strengthens, it makes the price of gold relatively more expensive in other currencies.

As well as this, if the dollar rises the opportunity cost of holding gold is higher. In this scenario, holding cash becomes more attractive, making the need for gold as a safe-haven less necessary.

However, with the Fed choosing not to raise interest rates so far this year, and other central banks such as the UK and the ECB cutting rates, the traditional drawback to gold – that it is a non-yielding asset – has been somewhat negated.

Gold has therefore outperformed both equities and bonds in 2016, while being far less volatile than oil – the only asset class to outperform the metal so far this year.

Performance of indices in 2016

 

Source: FE Analytics

“In recent months, equities have been driven more by expectations of lower for longer central bank policy rather than the tentative improvement in economic fundamentals,” he said.

“While momentum driven rallies can sustain themselves for some time, equities are now vulnerable.”

However, while equities have performed comparatively poorly so far this year - even the much-ballyhooed emerging markets have returned less than gold – some remain sceptical.

“There are those who believe that gold will only perform in a negative real yield environment – i.e. where inflation is higher than yield levels – and we’re not quite there yet,” Peters said.



Gold remains some way from the highs seen in 2011, as the below graph shows, but Peters says there is still an investment case for owning the metal within a portfolio.

Performance of indices over 5yrs

 

Source: FE Analytics

Commodity prices have largely fallen across the board over the last five years, with gold one of the most affected, but with equity prices reaching new highs, Peters argues that equity markets now look expensive, and investors could look to other areas.

“Gold can function as a safe haven during times of market volatility and provide strong countervailing returns to equities,” Peters said.

He says equities could repeat the volatility that occurred earlier this year, and if inflation rises, as some predict, gold could provide a good store of value.

In truth, it can be hard for investors to know when a good time to buy gold is, with sentiment a bigger driver than fundamentals.

However, with market volatility largely expected to remain for some time, now could be a good time to buy the safe-haven asset.

“As structural positions, they are unlikely to be sold in a hurry,” Peters said, adding that he has added a gold position to two of his multi asset total return funds for this reason.

“This should provide a strong source of countervailing returns to equities if we see further volatility and allows the funds to continue seeking capital growth opportunities in what remains an uncertain environment.”

“[However], this assumption needs to be watched closely as changes in sentiment and the growth outlook fluctuate,” he warns.

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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.