The coronavirus pandemic sparked investors worldwide to rush into safe-haven assets, but it is the ongoing central bank response that will give gold more room to run.
The precious metal has rallied significantly since the crisis began, breaking all-time highs, briefly crossing the $2,000 per ounce mark and is trading just below it currently.
At the latest virtual Jackson Hole central bank summit, Federal Reserve chairman Jerome Powell told investors that monetary policy will likely aim for inflation “moderately above 2 per cent for some time”.
And Ned Naylor-Leyland, manager of the $988.8m Merian Gold & Silver fund, said this has effectively meant that “Powell has turned into Moses parting the Red Sea”.
He said: “Gold and silver move based on real rates, and since real rates are inflation and official rates what Powell has done has held both aside and said, ‘run through here quickly’ to the golden promised land on the other side of the Red Sea.”
One side of the water is inflation, and the other side is interest rates, and Naylor-Leyland described Powell as “holding one side of the water back [interest rates] and trying to create inflation on the other side.”
“Both of these things drive real interest rates down and gold and silver up,” the manager said. “He has turned into Moses, parted the wave and said ‘quick, come in now, get across, before this all comes crashing down’.”
“That’s why Warren Buffett’s joined in [with his acquisition of a stake in Canadian gold miner Barrick Gold]. Everybody’s capitulating because at the core central bank level, they’ve said they are going to be managing both components of real yields in favour of gold ownership.”
He said this contrasted with central banks’ historical stance where the opposite has been true.
“They were underreporting inflation for the opposite reason, they didn’t want gold to go up because they were trying to sell their paper,” he explained.
Performance of Bloomberg Gold Sub index over 20yrs
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Source: FE Analytics
As the above chart shows, over the past 20 years, the Bloomberg Gold Sub index has risen 511.61 per cent in US dollar terms, but it has experienced notable ups and downs over the period.
However, the dash to gold in the recent and not-so-recent past has ultimately been down to real yields, according to Naylor-Leyland.
The manager attributes the move up in gold between 2000 and 2011, due to a slow and gradual, but consistently fall in real interest rates during the period. Gold then experienced a noticeable spike after quantitative easing (QE) started being openly discussed in 2008 following the global financial crisis. But between 2012 and 2018 gold fell as a result of central bank forward guidance suggesting a markedly higher real interest rate environment.
“The central banks suddenly said they were going to do four-to-six rate hikes,” he said. “If you remember it took them four-to-six years to do a single one, but the bond market priced it all in straight away,” recalled Naylor-Leyland. “Gold and silver got crushed based on language from central bankers that makes their currencies look less bad than they actually are.”
When it comes to the present, he said the pricing of gold is still down to real yields – unless people start asking where the physical gold and silver is, which Naylor-Leyland said would be a major catalyst and something that may already be underway.
He said: “The fact that central banks have been repatriating reserves from each other ever since they started doing QE [quantitative easing] is your biggest signal that it’s already happening.”
Central banks are amongst the largest holders of physical gold. According to the World Gold Council, the Federal Reserve holds 8,000 tonnes, 79 per cent of its foreign reserves, in gold.
Naylor-Leyland said that unlike investors “the central banks don’t carry any risk by holding the paper [currencies] because they have so much gold in their reserves that it neutralises all the risk”.
He said as central banks can do whatever they like with their currency, the people at risk are those who don’t own gold because they haven’t neutralised the risk.
“If you have 30 per cent of your reserves in gold and 70 in paper and you set fire to the paper, all that happens is that the ‘value’ in the paper just ends up in the gold,” he said. “Central banks not only understand this, they’re managing the situation specifically in that direction.”
However, before considering an investment into gold, there are some important misconceptions about the precious metal Naylor-Leyland said investors should understand.
One of the most common misconceptions investors should reconsider is the idea that gold is an asset class or an investment.
“Physical [gold investment] is dis-investing,” the manager said. “It is to refuse to participate in the modern fiat financial system. It is not only not an investment, it’s the opposite of investing, it’s the risk-free.
“You will not lose purchasing power against goods and services over the medium-to-long term, that is why its sound money, it won’t degrade.”
The second misconception he believes investors should tackle is the idea purported by the likes of Warren Buffet who famously said he does not invest in gold because it pays no interest.
“Does a £20 note pay interest?” Naylor-Leyland asked. “The answer is obviously ‘no’.
“What happens when you put it on deposit? In both cases [with gold and a £20 note] you can generate interest. It’s not just wrong, its fundamentally leading people away from the truth by trying to pretend that gold isn’t money.”
He added: “If you lend your gold you are going to get a far better return than sterling, yen or dollars. It’s about real interest rates, and the fact is, you can lend gold and generate interest off it.”
“You can lend the leaves in your garden and generate interest, granted you have to find someone to borrow them off you.”
Finally, Naylor-Leyland noted Warren Buffett’s investment into Barrick Gold highlighted in Berkshire Hathaway’s most recent quarterly filings and the trimming of positions in some banks.
This, the manager ventured, may have something to do with Buffett’s father, senator Howard Buffett – a strong supporter of the gold standard and the author of several books on gold.
“Warren’s great hero, the biggest goldbug in US congressional history, is his dad,” he concluded. “He’s funnily remembering it all at the right moment in the cycle.”
Performance of Merian Gold and Silver
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Source: FE Analytics
The Merian Gold and Silver fund has delivered a total return of 125.24 per cent in sterling terms over the last five years. It has an ongoing charges figure (OCF) of 0.88 per cent.