It's now smart to hold some gold
THE TELEGRAPH - BY TOM STEVENSON
For years on end, the gold price is only of interest to the kind of people who stockpile tinned goods and Kalashnikovs. Then suddenly everyone’s wittering on about it. Interest in the precious metal tends to rise in those rare periods when someone you know has made money holding it. Well, the gold price has risen 23pc since last August and, guess what, it’s the talk of the markets right now.
Gold hit a six-year high last week as nervous investors focused on its safe-haven appeal at a time of heightened worries on several fronts. The shooting down of an Iranian drone in the Gulf reminded us of the potential for things to go badly wrong in the Middle East.
Then, a new record high for the S&P 500 started to look optimistic as earnings season disappointments confirmed what a challenge it will be for corporate earnings to justify today’s valuations. Meanwhile, the Fed is seemingly heading towards the start of a new easing cycle, threatening a weaker dollar and even more negative yielding bonds - both historically good for bullion.
No wonder, the gold-bugs are reheating their "told you so" schtick. And it’s not just the usual rent-a-cranks who are making the case for gold. Ray Dalio, founder of the $150bn investment firm Bridgewater Associates, is touring the TV studios talking about a "paradigm shift" in markets as central banks become ever more desperate and resort to measures that will devalue paper currencies against traditional stores of value like gold.
I can list plenty of good reasons not to invest in the yellow metal. It pays no income; it is expensive to store and insure; it has next to no intrinsic value; no real use beyond looking pretty; it’s extremely volatile; it’s a greater-fool investment, requiring another buyer to believe it is going higher; and its value was higher 40 years ago in real, inflation-adjusted terms.
And yet, a good case can be made that the last year’s rally in the gold price to about $1,450 an ounce has further to go. The first argument focuses on the balance of supply and demand. Unlike with oil, where both parts of the equation fluctuate, the gold price is all about demand as production is relatively stable.
This year, demand looks set to be the highest in four years as purchases for jewellery rise in the world’s two big gold consumers, India and China. Consumption of 4,370 tonnes this year will the highest since 2015, according to the Metals Focus consultancy.
The second case is technical. With no yield to measure, gold is as cheap or expensive as you think it is. This makes fundamental analysis difficult and investors therefore tend to rely on the charts for guidance. These are showing a clear break-out from the trading range in which gold has languished for the past five years or so. As chartists will tell you, the trend is your friend.
The third element in the bullish case is the outlook for the dollar as the Fed gears up to cut interest rates at the end of the month, perhaps by as much as half of one percent. That matters because it reduces the opportunity cost of holding gold - the less you can earn on a risk-free investment like cash or a government bond, the less reason there is not to hold yield-free gold.
The expected turn in the interest rate cycle, with some expecting US rates to head back towards zero, will only exacerbate the $13trn headache of negative yielding bonds. That’s how much is tied up in bonds where investors are prepared to accept a small guaranteed capital loss in return for the certainty of getting most of their money back in the future. In that environment, gold looks relatively attractive. It will be doubly so if lower interest rates weaken the dollar, reducing the cost of the metal to buyers outside the US.
Perhaps the best argument for holding some gold in your portfolio is its ability to reduce the risk that all of your investments will fall at the same time. It is a great diversifier, an increasingly important factor at a time when bonds and shares have started moving in lock-step as investors focus on the outlook for interest rates.
Whether you look at gold versus the economy or compared with the stock market, it marches to a different beat. And, as we have seen, the correlation with the dollar is negative - they move in opposite directions. The amount of gold that most investors are likely to hold will not offset a serious market correction, but it might take the edge off it.
So, if you are tempted to add a bit of gold to your investments, what is the best way to get an exposure? There are three principal ways. First, you can buy the metal itself, either as coins or bars. Given that you are probably buying gold in part because you don’t trust the system anymore, this has the merit of allowing you to touch your investment and reassure yourself that it is really there. The disadvantage is that, short of keeping it under your mattress, you will have to pay someone to look after it for you and insure it.
More realistically, you can invest in an ETF which actually invests in the metal itself or, preferably in my view, you can invest in gold mining shares, either directly or via a fund like Investec Global Gold. The advantage of investing this way is leverage.
Newmont Mining recently said its cost of production was about $900 an ounce, so every extra dollar on the gold price falls straight through to the bottom line. High fixed costs mean that, in a rising market, profits rise faster than the gold price itself. This gearing works both ways, of course, but if you don’t think the price is going up then you probably shouldn’t be investing in gold anyway.
Tom Stevenson is an investment director at Fidelity International. The views are his own. He tweets at @tomstevenson63