Gold and silver
01 Sep 2016 | By Ned Naylor-Leyland

Gold’s perfect storm

No one would argue with the fact that, as investors, we live in uncertain times. Heightened geopolitical tensions and growing monetary policy instability are causing investors to become increasingly risk averse.

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No one would argue with the fact that, as investors, we live in uncertain times. Heightened geopolitical tensions and growing monetary policy instability are causing investors to become increasingly risk averse. And yet the paltry returns in bond markets, buoyed by endless quantities of central bank buying, are forcing investors to look for yields in increasingly riskier areas of the market, notably credit and high yielding equities. Investor mistrust of the current rally is what is causing certain investor ‘heavyweights’ to move from financial assets into physical assets. We would not argue with this unprecedented move.

The price of gold, in our view, is the beneficiary of a ‘perfect storm’ of three converging and interlinked factors. At the heart of the storm lie the actions of central banks. Having pumped endless amounts of liquidity into the system, through the mechanism of quantitative easing (QE), global bonds yield virtually nothing, or in some cases, have negative yields. The resultant hunt for income has caused investors to turn to riskier credit markets, and other higher yielding instruments, in an attempt to seek a ‘decent’ return on their capital. In so doing, their key aim, which is to preserve capital, has been put at risk.

A further consequence of QE has been the devaluation of so-called fiat, or paper currencies. Ongoing currency wars have only served to increase global imbalances further, creating debt mountains in the process, and calling into question the ability of governments to fund their deficits.


On the horizon lie additional worrying trends. Worsening relations between Saudi Arabia and Iran continue to fuel mounting concerns about supply disruptions, despite the fact that supply for crude oil remains in excess of demand. Another perturbing trend engulfing markets is the rise of nationalism. Driven by a disaffected cross-section of the population, suffering from the effects of real wage erosion and new waves of immigrants, the effects of nationalism are starting to emerge on a global scale.

The manifestation of such a trend, and a more general rejection of ‘globalisation’, is everywhere. In the UK’s Brexit vote, in the rise of the far right in France, the growing murmurings of the far right in Germany, and most obviously in the worrying rhetoric of Republican presidential nominee, Donald Trump.

Yet, in spite of the creation of a near perfect environment for gold, investors are still significantly underweight in their allocations to the precious metals sector. That contrasts markedly with the holdings of central bankers, who have been net buyers of gold since 2009, and a number of high-profile hedge fund managers who have revealed in their latest regulatory filings that they do not trust the rally in either equities or bonds.

There are a number of reasons why the average investor has shunned gold and silver. The first is that neither metal is in any formal benchmark index and therefore there is no obligation to hold precious metals. The other reason for not holding precious metals is potentially the degree of choice on offer. In the 1970s, the amount of gold in an investor’s portfolio might have been around 20%, but the variety of financial instruments available to investors, back then, pales into insignificance compared to today.


The low levels of gold allocations are disappointing, especially in light of the yellow metal’s key role as a portfolio diversifier. According to Bloomberg, figures show that gold has a negative or near negative correlation with both equities, 3-month US dollar Libor and emerging market equity indices over one, and three years. On a five year time-frame the correlation is at, or close to, zero. As any investor knows, negative correlation amongst asset classes is ideal for optimal portfolio allocation.


As I write, markets are at something of a crossroads. Investors, everywhere, are calling into question the efficacy of monetary policy, while governments on a global scale are flirting with the idea of boosting anaemic demand through the use of fiscal policy. Devalued currencies, such as the pound and the euro, appear to be facing a stagflationary future. In my experience, gold performs well in both inflationary and deflationary negative, real yield environments.

The fact that precious metals are so under- owned, I believe, is a real opportunity for individual investors to consider whether they should own gold, both as a risk management tool and as a source of capital preservation that hedges against both inflation and currency devaluation. In today’s uncertain times, a fully comprehensive insurance policy is needed as a systemic hedge. The only type of insurance policy which offers this, in my view, is gold.


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