Why is the gold price rising so fast?

Several reasons, some linked to each other, are behind the recent price action in gold.

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  1. Rob Morgan

The gold price recently hit its highest levels in six years at around at $1,450 per troy ounce. The price of the metal is up 12% over three months – and 17% in sterling owing to the weak pound. Despite the recent upsurge in the price it is still well below the all-time high of $1,921 in September 2011. Following a long and largely lacklustre period for billion why the sudden upward move?

The main reason is a fall in bond yields – or the interest rate paid out by bond issuers – which move inversely to prices. Many of the safest government bonds now have negative yields, meaning that investors are effectively paying to lend money to very secure borrowers. This rather odd situation makes gold look more attractive.

Gold doesn’t pay any income, and now there is less ‘opportunity cost’ for holding it versus traditional safe havens such as bonds and cash when interest rates are so low.

The reason for bond price weakness is the expectation of interest rate cuts by the US Federal Reserve. The Fed confirmed at its June monetary policy meeting that it is prepared to cut rates to support the US economy, a turnaround on their previous view. It was only seven months ago that the Fed seemed set on a path to raise interest rates even further.

Linked to this is a fall in the US dollar. If US rates are to be cut then investors are less attracted to the currency as it pays less interest to them – so the value falls. Gold is priced in dollars so weakness in the currency attracts lots more bullion buyers as it becomes cheaper in their local currencies.  A number of emerging markets, for instance India, are important buyers of gold.

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 Iran has made some investors nervous.

 

Advantages of gold…

To say gold’s status of a store of value is well established is something of an understatement. For much of human history gold has been used as a means of exchange. Its rarity, decorative properties and longevity made it perfect for this.

Today, gold fulfils a special role, though it tends to divide investor opinion. To ‘gold bugs’ it is the one true currency that cannot be debased, that is to say lose its value to inflation over time. It often becomes the go-to asset in times of crisis, or when fears persist that interest rates on paper money aren’t enough to compensate for inflation – the rise in price of goods and services.

This can make it a useful diversifier in a portfolio. Gold 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 gold should rise (or fall) at roughly the rate of inflation (or deflation). This is due to the finite amount in existence and assumes that any new supply from mining is roughly equal to additional demand.

 

…and the disadvantages

Gold has little practical use due 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.

So although gold is often said to be a ‘safe haven’ asset, in terms of shorter term ups and downs it can be anything but.

 

How to invest in 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.

It is possible to buy exposure to gold via 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 is added risk and complexity. One example is iShares Physical Gold.

Another route into gold is through shares in gold mining companies. These tend to represent a ‘geared’ play on the gold price, meaning that 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 more risky firms could even swing from profit to loss or vice versa on bullion’s moves.

The fund on our Foundation Fundlist investing in this higher risk area is Blackrock Gold & General. Managed by Evy Hambro and the well-resourced Blackrock's Natural Resources Team, it invests in gold and other precious metal-related companies on a worldwide basis.

Like other funds in this specialist area, it has been through a bleak couple of years but has started to pick up strongly in recent months due to the gold price rise. 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.

 

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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