Going, Going, Gold

Our view on gold has changed recently and we have sold the positions in full across all portfolios.

Gold has a few things going for it. It has had a prescribed value for thousands of years – stemming directly from the fact that it was, for much of the past three millennia, a medium of exchange, a savings product – in effect a currency. In 1971, when the US finally came off the gold standard, the direct link between paper currencies and gold was lost. Forty years is a relatively short time in a period measured in centuries, so institutional and personal memories of the linkage remain strong.

However, Gold is an example of a putatively safe asset which is, on investigation, not reliable in all environments. Gold is not necessarily a beneficiary from higher inflation, as is commonly thought.

The price of gold demonstrates no stable statistical relationship with the measured rate of inflation. No matter whose CPI series one adopts, the relationship is unstable by virtue of the very large swings in the gold price. The case for believing that gold offers a very long run store of value is not well constructed.

In face of these inconvenient facts, when we have invested in gold, we have sought entry points where we have evidence that the metal is relatively out of fashion. This is somewhat easy to spot as gold is an asset that is mentioned by portfolios managers many times more than its actual utility as an asset would merit. Gold holdings have ready acceptance in private investor circles and, by extension, private client asset managers.

Figure 1: Gold in USD terms (2005-2018)

Source: Bloomberg

Figure 2: Gold in USD terms (2014-2018)

Source: Bloomberg

Until recently gold benefited from the weakness of the USD as it is an asset priced primarily in dollars. That has allowed gold to reach a recent high of US$1358 but with notable resistance at US$1350.

We believe gold will struggle in a stronger USD environment and there are some signs of this paradigm developing now. The primary consumers of gold are emerging markets such as India, Pakistan & China where demand is doubly impacted by a higher interest rate environment if USD is also strengthening.

We also note that gold did not operate as a haven particularly well during the recent period of market volatility. Although we saw some oscillations between the 1300-1350 zone as markets swung from pessimism to optimism, there was no convincing break upwards in February 2018. This lack of performance was also observed during elevated periods of geopolitical risk viz. North Korea tensions.

Figure 3: Broad Dollar Index

Source: Bloomberg

Gold suffers as an asset class during periods of rising interest rates as it has no intrinsic yield of its own. The trajectory of the Fed is clear enough. As such the opportunity cost of foregoing the yield on risk-free cash to hold gold will continue to loom large in investors’ minds.

To conclude, we believe the current mix of macro factors in heavy for gold and we have excised the holdings from portfolios.

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