Originally published by Brooks MacDonald, an investment partner of Wren Sterling
Gold has arguably been a very successful chameleon asset class, able to draw on a variety of investment propositions to support a positive view. These have included suggesting risks ranging from, a sustained economic global depression; an out-of-control rise in inflation; the loss of the US Dollar as the world’s reserve currency alongside fiat currency debasement generally; and finally the attractions of a relative valuation to other (greater) negative-yielding assets. Taking these views in turn however, we see risks to each as a long-term support for gold.
In such an outcome, Gold would be seen as a defensive asset – a relative store of value. Currently however, while the consensus view is for a significant impact to near-term economic activity, we do not see a prolonged recession or depression. Indeed, the latest estimates from the International Monetary Fund (IMF) in June continues to show more of a V-shaped economic recovery as we look forward to 2021, with expected global real GDP growth this year of negative -4.9% year on year, rebounding to an estimated positive +5.4% year on year in 2021.
If global inflation was to pick up markedly, this would be very supportive for real assets, such as gold. Currently however, inflation rates in the US and Eurozone for example are very low and materially below the +2% inflation targets that the respective central banks in these regions target (US headline inflation rose a muted +1.0% year on year in July). Equally, when looking at longer-dated market inflation expectations, these also continue to be below the +2% inflation targets that central banks set.
Debasement of fiat currencies
If there was a significant loss of confidence in fiat currencies (such as the US Dollar, or the UK Pound for example) as a store of value, this would encourage markets to seek other assets, including gold. However, markets currently expect the outsized levels of monetary and fiscal accommodation to moderate going forward, as economies seek to see a staged exit from their enforced lockdowns. Indeed, at the June meeting of the Bank of England, its chief economist voted against the increase in Quantitative Easing (QE) and in the latest meeting in August, the Bank has also ruled out any near-term move into negative policy rates. This all suggests that central banks are not about to aggressively augment the current policy accommodation.
Relative valuation attraction
However, the most successful proposition for gold to continue to appreciate is a relative valuation argument. Even though gold, which pays no dividend and incurs costs to store and insure, suffers from a negative yield, this is still less negative when compared to other (greater) negative yielding assets. With US interest rates anchored towards zero, even muted inflation still leaves real yields for US 5-year or US 10-year government bonds negative for example. In order to build a constructive view on gold from here however, we would need to expect real yields to push further into negative territory. The best scenario for this would be a period of stagflation (low growth, high inflation) but given the outsized policy stimulus from central banks and governments, we are more likely to see a recovery in longer-term growth expectations and a modest recovery in longer-end bond yields. As we saw earlier this month, an inverse relationship to government bond yields can be especially damaging for gold, which on Tuesday 11 August suffered its worst one-day price decline in over 7 years, falling over -5%.
Ultimately, with US Money Market Funds in aggregate currently over $5 trillion in value, according to the US Treasury’s Office of Financial Research, (and equating to around 25% of US GDP in 2019) coupled with an increase of over $1 trillion in the past few months, an interesting question is where might some of this money go when holders are tempted to move away from cash? Will it be in US 10-year treasuries with nominal yields less than +1%, gold yielding nothing, or US equities which have a 12-month forward earnings yield (the inverse of the Price-to-Earnings ratio) at over +4%?
All data provided by Brooks Macdonald and as of 20 August 2020 unless otherwise stated. Past performance is not a reliable indicator of future results. Investors should be aware that the price of investments and the income from them can go down as well as up and that neither is guaranteed.
Investors may not get back the amount invested. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment. Investors should be aware of the additional risks associated with funds investing in emerging or developing markets. The information in this article does not constitute advice or a recommendation and you should not make any investment decisions on the basis of it. While the information in this presentation has been prepared carefully, Brooks Macdonald gives no warranty as to the accuracy or completeness of the information. This document is for the information of the recipient only and should not be reproduced, copied or made available to others.