Gold – Is now the time to shine?

What is the gold price telling us from an economic perspective, and what are the ways investors can add exposure to gold in an investment portfolio?

Philip Bowyer

Published: 06 Nov 2020 Updated: 13 Apr 2023

At the time of writing, the price of gold is trading at around $1,900 per ounce¹, having recently breached the $2,000 mark for the first time in history. What is the gold price telling us from an economic perspective, and what are the ways investors can add exposure to gold in an investment portfolio?

Gold has been used as a medium of exchange and a store of value since the ancient times, and it has a history of maintaining its value, where paper currency, coins and other assets have failed. This is partly because it takes years to go through the exploration and mining process to increase the supply of the yellow metal, whereas governments and central banks around the world can and do create hundreds of billions of new fiat (or paper) currency at the click of a button. This is known as Quantitative Easing, and it is achieved by central banks crediting their own accounts with newly created money and using it to purchase assets such as government bonds. In the long-run, the purchasing power of the currency is reduced through inflation. For this reason, gold has value to investors, and it can be used as a tool to hedge against the negative effects of inflation.

As the US Federal Reserve continues to aggressively increase the money supply through Quantitative Easing to help the economy cope with the impact of the current pandemic, we are observing downward pressure on the value of the US Dollar. Historically, gold has held an inverse relationship with the dollar, partly due to the denomination effect – as gold is denominated in dollars, but also because of changing inflation expectations and the state of the bond market. These driving forces of gold supply and demand are linked – institutional investors fearing a weakening dollar will move out of US Government Bonds and into other asset classes such as commodities, including gold, as an alternative safe-haven for their capital with at least the potential for some capital appreciation. This rotation is exacerbated in periods such as today, when interest rates on traditional ‘safe-haven’ assets such as bonds are so close to zero, and in many cases negative, providing nothing but ‘return-free risk’ as opposed to ‘risk-free return’. This is the case in numerous countries, including Japan and Germany, where owning a 5-year government bond would yield the investor -0.1% and -0.8%, respectively². The increasing stockpile of negative-yielding bonds shows no sign of slowing, there is now approximately $15 trillion³ worth of investment grade bonds in issue with yields below 0%. From a portfolio diversification perspective, it is becoming increasingly more attractive to own alternative safe-haven assets such as gold in place of bonds, so that there is at least the potential for capital return.

While monetary policy and inflation expectations are large drivers of the price of gold, it should be acknowledged that through history, gold has also acted as a hedge against crises. In times of extreme macroeconomic or geo-political uncertainty, the demand for gold significantly increases for its ‘safe-haven’ status, and this has long been the case. As Warren Buffett once said, ‘Gold is a way of going long on fear’. With the current pandemic situation causing a global economic crisis, fear levels in the financial markets are now particularly elevated.

We see then that the huge quantitative easing programmes across the globe are stoking inflation expectations, and investors have begun allocating some capital to gold in order to hedge against rising prices, a weaker dollar, a faltering global economy, and to manage volatility and risk within their portfolios. But should we be concerned about gold trading near all-time highs? The last notable peak in the price of gold was $850 in 1980, which adjusted for inflation translated to approximately $2,200 in today’s money⁴. This means that while the gold price today is high in nominal terms, it has some way to run before reaching inflation-adjusted all-time highs.

Investors wanting to add gold to their portfolios can do so by investing in physical gold, gold-related equities, or gold ETCs (Exchange Traded Commodities). Physical gold coins or bars can be bought at prevailing prices, but factors such as storage costs, security, and insurance to name a few make this an impractical method for many. Gold-related company shares such as those of gold mining companies will be influenced by the gold price, though many unrelated factors will affect the share price, and so the portfolio diversification benefits might be limited. Lastly, gold ETCs, which have become increasingly popular are really the easiest and cheapest way to gain exposure to the gold price. ETCs can be physically backed – where the fund holds the gold in a vault, or synthetic - meaning the exposure is achieved through the purchasing of gold derivatives. Synthetic ETCs possess additional risk in counterparty risk, associated with the third-party selling the derivatives.

Sources:

1. Reuters Eikon, 2 November 2020

2. Reuters Eikon, 2 November 2020

3. Bloomberg, World’s Rising Stock of Sub-Zero Debt has Investors Adding Risk, 27 July 2020

4. Macrotrends, Gold Prices – 100 Year Historical Chart Indexed to 1915, 2 November 2020

This comment should not be considered as a recommendation or advice relating to the acquisition or disposal of investments.

Capital at risk. The value of investments and the income from them can fall as well as rise and the investor may not receive back the original amount invested.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Risk warning
Investment does involve risk. The value of investments and the income from them can go down as well as up. The investor may not receive back, in total, the original amount invested. Past performance is not a guide to future performance. Rates of tax are those prevailing at the time and are subject to change without notice. Clients should always seek appropriate advice from their financial adviser before committing funds for investment. When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.

Notes to editors
Smith & Williamson is a leading financial and professional services firm providing a comprehensive range of investment management, tax, financial advisory and accountancy services to private clients and their business interests. The firm’s c1,800 people operate from a network of 11 offices: London, Belfast, Birmingham, Bristol, Dublin (City and Sandyford), Glasgow, Guildford, Jersey, Salisbury and Southampton. Smith & Williamson is part of The Tilney Smith & Williamson Group.

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