Investors should not make the mistake of buying gold on the back of its stellar rally so far this year, according to Royal London’s Trevor Greetham, who warns there are a number of factors as to why the price of the precious metal could come under pressure over the medium term. 
While it was one of the most hated asset classes going between 2011 and 2015 due a lack of inflation, a strong US dollar and the fact it offers no yield, gold has come massively back into favour over recent times.
There have been a number of drivers behind this, but its rally properly started when the US Federal Reserve raised interest rates in mid-December last year – an event many deemed to be a policy mistake at the time.
Not only have China’s woes spooked investors over that time, but global growth has remained subdued and there has been the growing concern that central banks around the world are running out of firepower to boost their respective economies.
On top of that, UK gold investors have massively benefitted from sterling’s post-Brexit plunge.
According to FE Analytics, the gold price has rallied 40.57 per cent in sterling terms since the Fed raised interest rates compared to a 20 per cent rise in the MSCI AC World index. While gold has rallied ‘only’ 20 per cent in dollar terms, it means the precious metal has still beaten global equities by more than five times in that currency.
Performance of indices since US rate hike
Source: FE Analytics
Thanks to its perceived ‘safe haven’ characteristics and its strong recent returns, data from BullionVault shows that demand for gold among private investors recently hit a three-year high. It also found that, by the end of December, 44 per cent of investors expect the gold price to have risen by 10 per cent, while 37 per cent envisage a rise of 20 per cent or more.
However, Greetham – head of multi asset at Royal London – says investors may have now missed the boat if they buy gold now in the expectation of stellar gains.
“The gold price is up 25 per cent year to date in dollar terms and 40 per cent if measured against the devalued pound. However, a constructive view on the US and UK economies means we don’t see this as the start of a long bull market,” Greetham (pictured) said.
He says there are a number of reasons why this is the case, but most importantly is his belief that the consensual view of the trajectory of the global (and most importantly, US economy) is wide off the mark.
“Gold tends to do well when the dollar is weak and when long term interest rates are falling.”
“Recent economic data out of the US has been on the soft side, so we wouldn’t be surprised to see a weaker dollar and low rates give gold another short term boost, especially if the Fed decides not to hike rates at its policy meeting this week.”
For example, FE data shows that while the dollar has strengthened relative to the pound (largely due to the build-up and outcome of the EU referendum) it has fallen by 2.83 per cent against the likes of the euro in 2016 – which has helped gold.
Relative performance of currency in 2016
Source: FE Analytics
Greetham continued: “Looking further out, we’d be more pessimistic on gold because we’re more optimistic on the US economy and we expect US interest rates to rise.”
“With monetary policy still easing in Europe and Japan and China guiding its currency lower, we see upside in the dollar versus the currencies of its main trading partners over the next few years. We’d also expect long term interest rates to rise in real terms as monetary policy returns to normal and this will further dampen the attractions of gold.”
Of course, there are many who disagree with Greetham’s view.
The majority of gold bulls argue that as nearly all central banks are hell bent on depreciating their currencies via extraordinary monetary policies and that global growth is still subdued despite eight years of money printing and ultra-low interest rates, more and more investors will turn to gold as a store of value.
There are those who are more balanced, however.
Given macroeconomic factors, numerous industry commentators argue that gold has once again proven it should play a role within a diversified portfolio.
Jason Hollands, managing director at Tilney Bestinvest, recently told FE Trustnet that a small allocation to physical gold in portfolios is prudent given weak global growth and the high valuations of both equities and bonds.
“It’s been the provision of vast amounts of liquidity by central banks in recent years that has sustained a prolonged bull market in both shares and bonds, but there is an increasing perception that central banks have now reached the limits of what can be achieved through monetary policy having experimented with ultra-low rates, quantitative easing and negative rates,” he said.
“Normally we are not fans of unproductive assets with no yield but these are not normal times with vast swathes of the government bond markets now offering up negative yields. While yields are so low on bonds, the opportunity cost of holding a zero-yielding asset like gold is therefore low.”
Gold has certainly helped investors over recent times.
For example, over the past 12 months the gold price has had a correlation of just 0.01 to the FTSE All Share and 0.58 to the FTSE Actuaries UK Conventional Gilts All Stocks index. Thanks to those correlations and its recent returns, gold has done wonders for a balanced portfolio.
Indeed, while the FTSE WMA Stock Market Balanced index has returned 15.60 per cent over one year, by adding a 10 per cent gold weighting to that index the gains have increased by 5 percentage points.
Performance of index versus composite portfolio over 1yr
Source: FE Analytics
More importantly though, by adding gold to the portfolio, investors would have witnessed a lower maximum drawdown and annualised volatility but better risk-adjusted returns (as measured by the Sharpe ratio).
While Greetham, whose recently-launched Royal London Cautious Managed fund is outperforming its sector since inception last year, understands why investors may want a small holding in gold, he urges investors to realise that recent returns from the metal won’t be repeated.
“A tactical holding might still be worthwhile to a sterling-based investor expecting another large move downward in the pound on the foreign exchanges,” he said.
“However, the UK economy is showing a lot of resilience to the Brexit shock and, while sterling weakness is a deliberate part of the policy mix, we don’t expect June’s dramatic plunge to be repeated.”