Can gold continue to shine?

The gold price has just set a record. Rob Morgan takes a look at the prospects and some options for investing in the area.

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  1. Rob Morgan

Gold has recently soared to an all-time high of $1,944 an ounce, usurping the commodity's previous price peak seen in 2011 amid the European sovereign debt crisis. This year to date the bullion price has risen by around 25%. Silver, which is often even more volatile than gold, has fared better still, rising 34% despite at one point being 34% lower than at the turn of the year.

What’s behind this strong performance and could there be further to go? To answer these questions we need to look at the fundamentals and the history of gold as a timeless store of value.

Gold: a unique asset

Owing to its rarity, decorative properties and longevity, gold has been used as a means of exchange and a display of wealth for much of human history. The fascination and appeal of gold to ancient civilisations remains today, which is why it tends to maintain its spending power over time. It also fulfils a very special role for investors.

Gold often becomes the go-to asset in times of crisis, but more importantly, it represents an ‘independent’ currency that cannot be debased. Paper currencies lose their value over time as more money is created, which is why interest rates on cash are often not enough to keep up with inflation – the rising prices of goods and services. In contrast, gold supply is finite, and expensive investment is necessary to discover and extract more of it.

This can make gold a useful diversifier in a portfolio. It doesn’t tend to be correlated with other commonly-held assets such shares or bonds – in other words, the price tends to do its own thing and it can rise when other assets fall – and vice versa. In theory, over very long periods (think decades rather than years) gold should rise (or fall) at roughly the rate of inflation (or deflation), though this assumes that any new supply from mining is roughly equal to additional demand.

Why is gold doing well now?

To stave off economic crisis during the COVID-19 pandemic the world’s Central Banks, led by the US Federal Reserve and the European Central Bank, have created vast sums of money, propping up businesses and individuals while the worst of the pandemic passes. This ‘monetary loosening’, the swelling of central bank balance sheets, and the spike in government spending have given investors reason to distrust paper currencies more than usual.

The suspicion is growing that Central Banks will willingly keep interest rates low while allowing inflation to run above target to help the economy recover and to gradually reduce their debt burden. In other words, “real rates” (interest rates after inflation) are expected to remain exceptionally low, even negative, for some time. This is the sort of environment in which gold tends to flourish. Not only can gold be trusted to retain its spending power over time compared with paper currencies, but the lack of interest on cash or government bonds means the ‘opportunity cost’ of holding gold (which pays no income and incurs costs to store safely) is lower versus traditional safe havens such as cash and government bonds.

A further supportive factor for gold is geopolitical tensions. The commodity is often viewed as a refuge during times of crisis, and the recent standoff between the US and China is increasingly making investors nervous. With second-quarter earnings numbers now coming in thick and fast, some are also keen to have a hedge in place against disappointing company updates.

Finally, downward pressure on the US dollar-linked to more aggressive monetary policy from the Federal Reserve is also helpful. Gold is priced in dollars and weakness in the currency can attract more bullion buyers as it becomes cheaper in their local currencies.  Several emerging markets, for instance India, are important buyers of gold.

Gold in a portfolio

Gold remains below its inflation-adjusted peak in 1980 – equating to around $2,200 in today’s terms – but given the current supportive environment it wouldn’t be a surprise if the price tested this level too. However, investors should be aware that a change in expectations, particularly towards a stronger economic environment and higher interest rates, could cause the price to drop quickly.

Although gold can be a great diversifier in a portfolio it does also come with several disadvantages. It has little practical use owing to its high cost and it yields no income. During ‘normal’ economic times it can become deadweight in a portfolio, or worse because it can be unpredictable and potentially volatile due to geopolitical events or supply and demand imbalances.

For instance, having more than doubled in the three years following the global financial crisis, it gave back half of those gains over the following couple of years. So, although gold is often said to be a ‘safe haven’ asset, in terms of short and medium-term ups and downs it can be anything but. That's why investors generally limit exposure to a sensible amount such as 5% of a portfolio, or perhaps 10% for those that are very bullish on prospects.

Options for buying gold

Some gold investors like to buy coins or bars – but this is unlikely to be a valid option for most people due to storage and insurance requirements. Fortunately, there are more convenient ways to add gold to a portfolio such as an exchange traded fund (ETF). We tend to prefer ‘physically-backed’ funds which own gold kept securely in a vault, as opposed to derivatives-based funds where there can be some added risk and complexity. One example is iShares Physical Gold, which is part of the Foundation Fundlist.

A higher risk route into gold is through shares in gold mining companies. These tend to represent a ‘geared’ play on the gold price, meaning they multiply the effect of a rise – but also multiply any fall. This is because profits can be highly sensitive to what the gold price is doing, and the riskier firms could even swing from profit to loss or vice versa on these moves.

The fund on our Foundation Fundlist specialising in this adventurous area is Blackrock Gold & General. Managed by the well-resourced Blackrock's Natural Resources Team, it invests in gold and other precious metal-related companies on a worldwide basis. The fund holds between 50 to 80 companies, the vast majority of which are established producers of gold, with exposure to pure exploration stocks (typically the riskiest in the area) relatively low compared with some of its peers.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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