“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
This comes from investment legend Warren Buffett, who is considered one of the most successful investors of all time and is the third-wealthiest person in the world with a net worth of $82bn.
But the Sage of Omaha’s opinion that gold “is neither of much use nor procreative” is wrong according to Paras Anand, head of asset management, Asia-Pacific at Fidelity International.
“We believe that contrary to Warren Buffett’s complaints about gold, gold is constantly offering useful insights, if you look closely enough,” he said.
Gold has classically been seen as a ‘safe haven asset’ and in keeping with this has rallied during the challenging conditions of 2019 as investors worried about the future direction of equity markets.
Bloomberg Gold Sub index versus MSCI AC World index over the past three years
Source: FE Analytics
Anand noted that “gold yields nothing and generates no cash flow, so it’s price is largely determined by the secondary market. In other words, it is only worth what other people are prepared to pay for it”.
This means that even investors who have no interest in holding gold in their own portfolios could find value in keeping an eye on its price movements, as the metal’s unique status means it can be “an interesting signal”.
There have been some “sweeping changes” to the structure of financial markets over the past decade following the growth of passive and systematic investment strategies, while ‘non-fundamental’ investing – or investment decisions that are not based on analysis of the value of an asset based on business or economic fundamentals – has become more prevalent thanks to central bank intervention and a regulatory changes.
“The result is that decisions to buy or sell securities are increasingly based less on notions of value and more on unrelated functional needs. There is less information in prices today, because there is far less wisdom in the crowds. In response, it is more important than ever that investors employ fundamental analysis, patient capital and wilfully ignore short-term price swings,” Anand said.
“Amid all these shifts, the market structure that has arguably changed the least is gold. Given there was never a concept of fundamental value, and it was never bought and sold on that basis, its underlying price drivers have remained consistent. So, could it be that in today’s market, gold is a rare source of wisdom?”
That said, the strategist conceded that the yellow metal appears to offer “a contrarian wisdom” as its movements over recent years have not been in keeping with what conventional thinking would suggest.
In the years after the financial crisis, many expected factors such as global central banks’ widespread use of quantitative easing and the sovereign debt crisis in Europe to lead to higher inflation and a bull market for gold.
But this never arrived. “Given the fragile financial system, dysfunctional politics and an apparent threat to fiat money, how did gold not catch a bid? Because counter to conventional wisdom at the time, inflation did not pick up with quantitative easing. It collapsed,” Anand explained.
“Even when it is strengthening, the gold price is surprising. To the extent gold is an alternative store of value to the US dollar, it would be expected to move in the opposite direction to the currency. But recently it has been making material gains despite a strengthening dollar. Signs that the gold price is defying conventional wisdom suggest we should dig a little deeper.”
He added that gold prices could be giving off two very different signals today.
The first potential signal is, because of gold’s theoretical value (as an asset which yields nothing) its value should increase when the amount of negatively yielding assets increases.
“In this explanation, gold’s rising price is a sign that negative real rates will persist, and the recession already priced into many asset classes will be more severe than consensus expectations,” he said.
Anand does, however, acknowledge that there are holes to this argument. The major ones is that the amount of negatively yielding assets is currently as historic levels, which would suggest that market is expecting the recession to be very severe.
But the strategist pointed out that many of these assets – government bonds and the like – will have been to meet capital adequacy requirements or provide liquidity, meaning their yields probably say less about future economic prospects than the changes in market structure.
The second major market indicator that could be given by gold currently is on inflation, as Anand argued that higher gold prices could signal a pick-up in inflation.
However, Anand said this feels less likely, even with fiscal policy is loosened. That said, gold prices did correctly seem to predict that QE would not lead to the expected increase in inflation after the financial crisis.
“If gold proves correct this time in signalling higher inflation, investors take note, given the impact this would have on asset prices across markets,” he concluded.
“It has always been wise to listen to Mr Buffett. But given the seismic shift in market structure in recent years, gold may yet prove to be an indicator not only of ‘bandwagon’ investor behaviour but broader economic expectations.”