Gold is back in the spotlight after an increase in geopolitical risks
Gold has been used as a form of currency and store of value since long before paper currency was invented and adopted across the world. Today this precious metal divides opinion among investors like few other asset classes. At Rathbones, we prefer to simply examine the evidence and assess its properties.
It is often touted as a hedge against inflation. Yet our analysis shows that what really matters for gold prices is the level of real rates — the difference between the stated rate of interest and the prevailing rate of inflation. As real rates fall, either due to a rise in inflation or a fall in interest rates, gold tends to appreciate and vice versa (figure 3).
As a form of hard currency that cannot be printed, gold can also provide a hedge against dollar debasement as well as the concept of fiat (paper) currencies in general. As the dollar weakens, gold usually performs well, but the two do not always move in opposite directions. For example, at the start of 2016 the dollar and gold prices appreciated at the same time, fuelled by fears of a hard landing for China’s economy.
A hedge against tensions
Another well-proven property of gold is that of a hedge against rising geopolitical tensions. This relationship has been demonstrated during numerous periods in the past, with the most recent example being the sabre-rattling between the US and North Korea. As tensions have increased, gold prices have risen.
The precious metal serves as the ultimate hard currency and should perform well in a highly inflationary environment where confidence is lost in central bank policies and faith in the monetary establishment is shaken. These conditions are likely to be deeply damaging for most other asset classes. But it is not necessary to have such a grim outlook to justify a modest allocation to gold bullion in a multi-asset portfolio.
Looking ahead, real rates are likely to remain subdued as central banks look to stay ‘behind the curve’ to avoid killing off the economic recovery, while trying to maintain their credibility as stewards of our financial system. In such an environment, we view the opportunity cost of owning gold as an investment as relatively low.
Hedged or unhedged?
For the ‘purest’ way of obtaining exposure to gold, we invest in exchange-traded funds that own physical gold bullion in secure vaults. The option exists to hold these funds on either a hedged or unhedged basis. In other words, we can choose to be protected against exchange rate fluctuations between the dollar and sterling or opt to participate in any movements as an added potential source of returns. For example, making an unhedged allocation to gold would make sense if we expect the dollar to strengthen against sterling.
In our opinion, you do not need to be a tin-hat-wearing gold bug to appreciate the yellow metal’s portfolio diversification and hedging properties in these uncertain times as far as monetary policy and geopolitics are concerned.
Figure 3: Inflation protection
As real rates fall, either due to a rise in inflation or a fall in interest rates, gold tends to appreciate and vice versa.
Source: Datastream and Rathbones.