The unprecedented central bank and government response to the coronavirus crisis has helped send some stock markets rallying past their pre-Covid levels, despite the fact that the pandemic continues to intensify in some parts of the world.
Yet what makes this rapid rally in stocks unusual is the fact that gold, typically inversely correlated to risk assets, has also experienced some of its best returns ever, surging to nine-year highs.
According to Bertie Dannatt, investment director at Ruffer, this can be largely attributed to the increased investment demand.
“Gold’s attractiveness is really a function of the relative unattractiveness of other currencies and asset classes,” he said.
Dannatt believes the impressive rally in equities since March has made their outlook incredibly uncertain and when “you’ve got a [bond] market offering no meaningful yield and negative yield in some geographies”, gold becomes relatively attractive.
“Gold is clearly benefiting from, what we believe at Ruffer we are witnessing now, genuine regime change playing out in front of us in capital markets,” he explained.
Why gold is attractive and gold miners are doing well
Dannatt believes that Covid-19 was not the cause of the correction of financial markets but has been the catalyst.
“It has catalysed this movement from an environment pre-March of this year – dominated by slack monetary policy – into one of slack monetary policy combined with slack fiscal policy, which I think is a potentially explosive mix with inflationary connotations,” he said.
“In a world where central banks are printing money and trashing their own currencies, gold becomes a relatively much more attractive investment.”
He emphasized that this was not a new phenomenon, pointing to when Richard Nixon abandoned the gold standard in 1971: “The price of gold was $35 per ounce then and today we’re looking at a price of $1,800.”
Investment demand for gold has sent the stocks of gold mining companies rallying faster than the price of the metal itself because if the cost of extracting and selling it are kept relatively low and stable, any increases in the price of gold is pure margin.
Many gold miners have also been one of the few higher dividend paying sectors to have not cut dividends. In some cases, they have increased dividends.
Accordingly, gold funds have joined US tech-focused growth funds as some of the top performing equity funds this year.
One of the top performing gold funds has been Paul Kennedy’s £1.4bn LF Ruffer Gold fund, which aims for capital growth by investing in gold and precious metal mining companies.
One of the ways the fund has managed to add alpha has been by capitalising on what Kennedy and Dannatt believe is a disconnect between prices of large gold miners and many small- and mid-cap miners.
“What we've done over the years in the build-up to this crisis is accumulate positions in some of these small- and mid-cap names and over the last few months we’ve seen some of that valuation discrepancy between large- and mid-cap companies close,” Danatt explained.
LF Ruffer Gold has less than one-quarter of its portfolio in large-cap gold miners and over three-quarters in mid- to small-cap names. Some 44.9 per cent is in mid-caps and 31.1 per cent is in small-caps.
The fund has returned 64.14 per cent year-to-date compared to the FTSE Gold Mines benchmark’s return of 42.48 per cent and a 18.8 per cent loss from the FTSE All Share.
Performance of LF Ruffer Gold year-to-date
Source: FE Analytics
The argument for inflation and gold
Some investors argue that much like after the global financial crisis just over a decade ago, quantitative easing will not result in inflation as many feared.
Dannatt believes that there is a market misconception that this crisis is going to play out with regards to inflation exactly like it did in 2008, which resulted in asset price inflation in equity and bond markets but not in the real economy.
“I think a lot of market investors think the same will happen this time but I think it will be a very different result,” he said.
“In 2008 there was only slack monetary policy; what we’ve now got is slack monetary and slack fiscal policy, so you’ve got huge amounts of money being injected into the real economy.”
Dannatt argued that 40 years of disinflationary pressure is giving way to a new reflationary backdrop, which will have interest rates close to zero and inflation remaining consistently above it and moving persistently higher over time.
Over the last 40 years, the impact of technology, the emergence of China and its labour force, shifting demographics of Western countries and the continued integration of the world economy through globalisation has been largely disinflationary.
However, Dannatt believes that we’ve seen their peak impact on prices and that some of these disinflationary trends have gone into reverse. He said the retreat of globalisation and the changing labour dynamic of China were good examples of this.
Ultra-low interest rates with inflation persistently higher will be supportive of Western economies with record levels of debt, keeping the cost of servicing it manageable and eroding it away in real terms, he pointed out.
“Politicians have discovered the magic money tree and they’re making all these promises around pay rises for key workers and huge infrastructure programmes to support their economies. They’re going to find it very difficult to let go of that,” he added.
While in the short term Dannatt has no high conviction of how the economic recovery plays out, he anticipates it will be an incomplete one.
“If it's incomplete, the gap of economic capacity is the size of the recession to come and given the choice between a full and complete recovery or an impressive recovery but one that ultimately falls short, our bias is towards the latter.”
While LF Ruffer Gold manager Kennedy noted that there still could be short-term corrections and there is a risk that gold is “swept up in another round of panic selling of other assets”, he believes in the long term there is more to come from gold mining equities.
He explained: “It appears we now face a prolonged period of weak economic growth, zero interest rates, 'unconventional' monetary policy measures and unfunded fiscal expansion.
“The implications for stock markets may be somewhat ambiguous, but the case for gold is about as good as it can get.”
Performance of LF Ruffer Gold over five years
Source: FE Analytics
LF Ruffer Gold has returned 295.24 per cent over a five-year period, compared to 213.02 per cent from the FTSE Gold Mines benchmark and 12.76 per cent from the FTSE All Share.
It has ongoing charges of 1.24 per cent.