Weighing up the merits of gold as volatility returns

Fall in stock markets reignites interest in the precious metal

Nothing seems to split opinion quite like gold. Everyone has a view on the precious metal and particularly when stock markets take a dive.

The FTSE All-Share has fallen more than 6% so far this month, marking the return of volatility to markets and putting gold back on the radar of portfolio managers. Yet the precious metal’s price in sterling terms has risen 3.3% to reach 10-week highs at £942 per ounce.

This spike comes following a sustained period of depression. In Q3 the price of gold fell 4%, dipping below $1,200 (£920) an ounce on the back of the strength of the US dollar. As such, four of the five bottom fund performers for Q3 were invested in gold and precious metals.

But the recent stock market dip has triggered a rally in the price of gold and raised familiar questions about whether now is a good time is to buy into the metal for its safe haven status – and how best to access it.

Look beyond the ‘chatter’

According to data from online physical gold platform Bullion Vault, net demand from retail customers has jumped six-fold from its previous 52-week average, reaching nearly 5,000 ounces. Bullion Vault research director Adrian Ash says the platform has not seen such a positive response since markets were rocked by the election of Donald Trump as US president.

Unsurprisingly, he says buying gold tends to gain appeal when other assets do badly. Over the past 13 years net demand to buy gold among Bullion Vault’s client-base of private investors has shown a far greater connection to moves in the stock market than it has to the price of gold itself (see chart).

However, he is quick to point out that while buying gold tends to gain appeal when other assets do badly, investors should look beyond the short-term relationship between the level of gold demand and equities because all the “chatter” about safe haven flows misses how gold has helped reduce longer-term losses on other investments.

Ash says week to week over the past 50 years, gold prices have shown no clear pattern with regard to whether the stock market rose or fell. But looking at five-year periods, gold prices rose for UK investors 96% of the time when the FTSE has lost value from a half-decade before.

The moral of this is that when people talk about gold as a safe haven, it becomes self-fulfilling and investors tend to move into it once a crisis has begun or the stock market has really started to lose value. However, he believes a better time to enter the asset class is actually when stock markets are strong.

“This safe haven idea happens because everyone rushes into gold when the stock market has been losing money for an extended period. If you want to invest in gold the best time is probably when stock markets look to be peaking and interest in gold is low.

“I’m not going to say now is the time for advisers to pump their clients into gold, but it is definitely worth looking at right now because if we do see an extended drop in the stock markets it may well be that in five years’ time, clients are saying, ‘Why didn’t you get me into gold?’ and ‘Get me into gold now’. If you’re going to diversify into gold the time to do it is not when you’ve already taken a big hit in equities.”

Hedge against systemic risk

Fund selectors and wealth managers are split over gold.

Iboss has had allocation to gold since early 2016 and currently holds 2% in the ETFS Physical Gold fund exchange traded fund and 1% in the Merian Gold and Silver fund, managed by Ned Naylor-Leyland.

Investment director Chris Metcalfe says the firm likes gold for its diversification and low correlation properties as well as because it acts as a hedge against systemic risk, particularly in an era of trade tensions between the US and China.

Metcalfe says the ETF is a cost-efficient way to access the gold market by providing a return equivalent to the movements in the gold spot price. The Merian fund, meanwhile, invests in physical gold and silver and a high percentage in mining equities. Iboss says the volatility of the Merian fund is the highest of any fund it holds which explains the low allocation.

So far in 2018 gold has made a negative contribution to Iboss’s overall performance, but this flipped to very positive from the beginning of October, as equity markets sold off.

Metcalfe says: “Our combined gold holdings have added over 3% month-to-date and it is exactly for times such as these that we hold them. That said, we don’t envisage further increases as there can be very long periods where gold is a drag on performance. It’s often in times of a more serious crisis when the value of holding these funds comes through, many of the major corrections going back decades have been a positive backdrop for the metal.”

Lack of yield 

Whitechurch Securities, on the other hand, is not keen on the yellow metal. It has a very small exposure indirectly through some of the absolute return funds it holds and through some mining shares held in global and UK equity funds.

In a note to clients Gavin Haynes, managing director at Whitechurch, says the investment team regularly gets asked why it does not hold gold in discretionary model portfolios and the answer, essentially, is because it pays absolutely nothing in yield.

Haynes explains: “With traditional safe haven government bonds having provided historically low and at times negative yields since the global financial crisis, the opportunity cost of holding gold as a safe haven store of value has been low – so conditions should have been favourable.

“However, we are now seeing a reversal of the quantitative easing policies and interest rates are beginning to rise. Although we expect a lower for longer interest rate environment there is little doubt that the direction is upwards, so the opportunity cost of holding gold is going to increase providing a headwind to the gold price. We favour earning 3% yield from US treasuries which provide a safe haven for tougher times.”

In addition, Haynes says since 2011 the returns from investing in a gold ETF have been far from glittering. As the chart below illustrates, over the past seven years one would have lost 20% from holding a gold ETF.

Source: FE

Gold miners are attractive

Rory McPherson, head of investment strategy at Psigma Investment Management, increased the portfolio allocation to gold earlier this year because of the dislocation of gold mining stocks and gold bullion – a void that is currently the largest it has been for 30 years (see chart below). Now the firm has a 2.5% allocation to gold in its balanced portfolio.

Source: Bloomberg

McPherson says Psigma has held bullion in the past but prefers miners because of the need to hold less which frees up money for other areas of the portfolio. “We tend to think the miners are going to be about three times as spicy as the bullion which can work well or badly depending on which way the price is going,” he says.

 

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