Gold is a bit like marmite – it divides opinion. As the saying goes, some love it and some hate it. Warren Buffett sees no value in owning gold, because he argues it will always underperform over the long term.
His argument is that, unlike dividend-paying stocks or bonds paying a yield, gold can’t compound over time. Other investors view it as a ‘safe haven’ – a hedge against the end of the world or an insurance policy against central bankers making mistakes.
It really feels like investors have to take a side at present. The gold market has been challenged by persistently high inflation – a move that has resulted in central banks raising rates quickly in response. Gold also trades in an inverse direction to the US dollar – with the latter recently hitting a 20 year high and reaffirming itself as the world’s reserve currency.
The gold price has suffered as a result. Having stood above $2,000 an ounce following the outbreak of war in Ukraine, it has since fallen to $1,620. The haters would point to the investment gurus who said gold was the best hedge against inflation. But it should be noted that due to the strength of the dollar, gold priced in yen, euros and sterling remains elevated.
But it is a far cry from the record highs we saw during Covid, at which I distinctly remember one investment bank claiming the price of gold could hit $3,000 dollars by early 2022 (which now seems a very optimistic view in hindsight).
While higher interest rates and a stronger dollar have hampered gold, the World Gold Council has pointed out that there are other factors that support the asset class. It states persistently high inflation could see gold playing catch-up with other commodities; we could also see increased appetite for the asset class amid market volatility linked shifts to monetary policy and geopolitics; while there will also be a need for effective hedges that overcome potentially higher correlations between equities and bonds.
The battle of the safe havens
With recession looming you’d think the appetite for gold would start to pick up again, but with rates rising across the globe, the reality is that bond markets may appear a more attractive alternative to investors at present, particularly with US two-year treasuries well above the 4% mark. Ask yourself this question: why would I hold gold when I can get an inflation protected income and gold yields nothing?
But – and this is a big but – we still believe the biggest threat to markets is a monetary policy mistake. And gold is a great hedge against policy mistakes and a collapse in the financial system. That hedge seems pretty cheap at the moment given the weakness in gold and the stress in said system.
The outlook is far from doom and gloom
As for the current environment, much will depend on how long – and how aggressive - the Fed is in its attempts to tame inflation. Jupiter Gold And Silver fund manager Ned Naylor-Leyland says inflation was the biggest worry for markets through the first half of this year, but what’s starting to dominate market discussions now is the data showing slowing economic growth and the potential for a recession.
He says the worry is the Fed will overtighten and have to pivot, with the dovish move potentially resulting in a sharp rebound in metal prices – adding that “gold and silver are bets that future real rates are not going to rise as much as the market thinks because the Fed won’t be able to pull it off”.
He also says a hard landing or recession won’t necessarily make inflation go away, citing a possible stagflation scenario.
With sterling appearing vulnerable over the short term to a larger inflationary shock than other parts of the world, Rathbone Strategic Growth Portfolio manager David Coombs believes gold looks particularly attractive to UK investors. He also feels the Fed is approaching peak rates – and gold will quickly become more attractive if markets also take that position.
He says: “People assume gold is an inflationary hedge, it is actually a stagflationary hedge – hence the comments around the UK. If it was correlated to inflation it would’ve always gone up given we’ve had positive inflation for the best part of 80 years. Often, when inflation is rising, interest rates follow suit, so optically it would look like gold is correlated to inflation.”
He notes that the bigger surprise is the reaction of the gold price to events in Ukraine – with gold typically rising when macro events like this take place (the price fell back after an initial rise). He feels this may be due to the US and the West being unlikely to be sucked into a land war with Russia – coupled with the strength of the US dollar.
“Dollar strength has overridden the go-to safe haven of gold, because the dollar is a reserve currency with a higher return,” he said.
With Fed rates unlikely to return to nominal levels in the foreseeable future, he feels gold could realistically return to $1,850-1,900 an ounce, while Ned Naylor-Leyland believes the asset class has a chance to break through the record $2,100 barrier as dollar strength is unlikely to last forever.
Ninety One Global Gold fund manager George Cheveley also says that, with the future being inherently uncertain, gold and gold equities remain a valuable hedge over the long-term, with the latter paying an increasingly attractive income.
He says at current levels, gold-mining stocks look attractive on both valuation and fundamental grounds. Even if headwinds for gold persist, he believes gold equities are enjoying their best margins in real terms for nearly 40 years – citing recent results with record cashflows for a number of companies. This was aided by many firms introducing or increasing dividends as well as share buybacks.
Darius McDermott, managing director, Chelsea Financial Services and FundCalibre. The views expressed above should not be taken as investment advice.