Gold rose from $1,455 to $1,747 during the three weeks to 14 April, as investors moved towards the safe haven amid the expansionary policies launched by central banks to combat the coronavirus crisis.
Gold has long been an important asset in portfolio construction as the traditional inverse relationship between it and equities offers a valuable hedge during times of market stress.
However, over recent weeks the yellow metal has been correlated with equities – gold and stocks fell together in March as the coronavirus pandemic sparked a sharp market sell-off, then both rallied together in April as policymakers unveiled massive stimulus packages.
Joseph Zhang, investment director at Fidelity, said when gold and equities become positively correlated, it usually suggests that the market is being driven by liquidity and changing real yields.
“We also saw this positive correlation amid the aftermath of the 2008 financial crisis, the height of the euro debt crisis in 2011-12, and during a period of rising real yields in 2018,” he said.
While this correlation could mean that a lower diversification benefit from holding gold, the uniqueness of gold means it remains an important asset in the hedging component of Fidelity’s multi asset funds.
It is also well positioned to benefit from the policies implemented by central banks to mitigate the effect on the economy.
Chris Forgan, a portfolio manager on the Fidelity Multi Asset Open range, which holds both physical gold and equity securities of gold miners, noted that gold has performed well since 2019, despite a period in March when investors were looking raise cash.
“This short sell-off in gold took place during a major drawdown and liquidity crunch with investors selling anything and everything in order to obtain US dollars,” he said.
Performance of gold over the last three months
Source: FE Analytics
That period of volatility in March has since passed, but there were also impacts on the commodity itself. Namely, shipping disruptions, refining capacity constraints and a decreasing demand from India and China for jewellery.
“But with the fading of these factors we see a return to normality and reduced likelihood of gold selling off with risk assets,” Forgan added.
Furthermore, the portfolio manager foresees a period of lower yields as being beneficial for gold.
“Most importantly, our view on gold is supported by the major policy responses from governments and central banks,” he said.
“Given the size of the monetary easing from global central banks, we see yields as likely to remain subdued. This is positive for gold as a non-yielding asset as lower yields reduces the opportunity cost of holding gold.”
In addition, a weakening of US dollar could increase demand for gold in other currencies.
The US is leading the way in terms of expansionary policy. Already, the US Federal Reserve has pushed interest rates near zero and committed to pump trillions of dollars into the economy.
“The conditions are ripe for some weakening of the US dollar,” said Forgan.
Whilst gold is primarily traded in dollars, a weak dollar is good news for investors outside of the US looking for cheaper gold. This too would affect the demand and price in the short term.
However, Daniel Ghali, a commodity strategist at TD Securities, argued that short-term demand for the dollar is very strong. He added that gold is caught between prospects of monetary inflation, which should support prices, and deflationary pressure from weak economic data.
“But in the longer term, this macro environment should actually lead to a lower dollar and that’s part of the positive gold story,” he said.
Moreover, economies around the world are likely to soon see their currencies fall in value and may have little choice but to pursue their own monetary easing.
Conversely, Forgan argued in the long run, the expansionary policies of governments and central banks may usher in a period of higher inflation; this would also be a positive for gold given its inflation hedging properties.
“Should there be a surprise consensus turn in sentiment based on positive news from the economic data, we could see gold come under pressure much like it did during the second half of 2016 and 2018,” he said.
Despite this, gold as a safe-haven and low real yields are enticing investors to turn to gold in these unprecedented times, according to Schroders strategist Sean Markowicz.
These features make the precious metal an attractive store of wealth when other financial assets deteriorate in value.
Whilst there has been a partial recovery of equities, the worst of the virus – both in peak number of cases and impact on the economy – is not behind us. This, warns Markowicz, could be a sign of a false dawn.
Portfolio protection of gold during S&P 500 drawdowns
Source: Refinitiv Datastream and Schroders
“The possibility of a double-digit recession or an anaemic recovery cannot be discounted. Against this backdrop, gold looks likely to remain a highly coveted asset in investor portfolios,” he said.
Changes in real yields is another reason for the growing inclination toward gold. All things being equal, a major deterrent for investing in gold would be that it pays no income compared with other safe-haven assets such as bonds.
This opportunity cost is diminished when real yields are negative, and demand could increase. This is supported by the graph below, as over the past year, gold has rallied on the back of declining real yields.
Gold mirrored the move of real yields
Source: Refinitiv Datastream and Schroders
However, Markowicz outlined that gold has not always correlated with real yields. Historically, the level of yield has dictated the correlation of the relationship.
“That is to say that, when bonds offer negative or low real returns, gold prices closely track changes in real yields. But when bonds offer high real returns, then the correlation between gold and real yields breaks down,” he said.