The first quarter of 2024 was a positive one for gold miners and punters alike, with the price of the precious metal increasing some 30 per cent since last year.
According to Amundi Asset Management, Europe’s largest investment firm, the precious metal went through a series of spikes, some of which were not easy to connect with specific events or fundamentals. There were, however, a combination of factors which contributed to this situation.
A highly liquid asset, it is well-known that gold has no liability and carries no credit risk. On top of that it is scarce, historically preserving its value over time.
It also benefits from diverse sources of demand – as an investment, a reserve asset, in the form of jewellery and a component of technology.
According to the World Gold Council (WGC), these attributes mean the yellow metal can enhance a portfolio in three key ways, mainly through delivering long term returns, improving diversification and providing liquidity.
While gold may, to a certain extent, remain vulnerable to economic conditions, it seems it is now managing to buck, and indeed take advantage of, a few current financial trends.
This, however, may lead to more hedging, an issue which in the past has caused some controversy as some producers either misread the market or forward sell reserves which simply don’t exist.
“Essentially, the rise in gold could signal a transition to a new phase of the economic cycle that might not look the same as the post-GFC era that has prevailed so far,” Vincent Mortier, Amundi’s group chief investment officer, noted.
“For now, markets remain busy assessing when central banks will start to cut rates.
“Beyond temporary doubts regarding the pace of disinflation, they are pricing that rates being held at elevated levels for a while longer will ensure that the economy returns to normal.
“The surging gold price appears to disagree.
“With rates structurally higher than in the last decade, a shallow ‘repair phase’ looming in the absence of any serious economic dislocations, an end to the China-led global trade expansion and shorter economic cycles will all be sources of continued uncertainty, (thus) calling for hedges.
“The uncertain medium-term inflation equilibrium, in a tug of war between inflationary pressures (including stalling globalisation and ballooning debt) and deflationary factors (including artificial intelligence-driven productivity and below-par economic growth) will also require hedges.
“Additionally, waning confidence in fiat currencies and a growing defiance against the dollar are supporting gold. Though a major currency crisis looks unlikely in the near term, profligate fiscal policies and diversification away from dollar transactions will steadily draw new fans to gold.
“A structural rise in geopolitical risk and domestic instability will also lead investors to rethink portfolio diversification – aiming to factor in a greater variety of risks with uneven timeframes amid scarcer liquidity, richer valuations and crowded allocations. Gold will be part of the solution.
“Because of its liquidity, diversification features appeal as an investment and to mitigate the implicit portfolio exposures to fiat currencies, gold will likely be granted a higher allocation.”
Moreover, the precious metal should be granted a sizeable allocation in diversified portfolios.
In essence, there are seven reasons for this, according to Mortier.
“First, it’s a liquid market with limited counterparty risk,” he noted.
“The most traditional way of investing in gold is by buying bullion bars or coins.
“Investors can also purchase gold exchange-traded products (including exchange traded funds, or ETFs) or gold certificates to avoid the risks and costs associated with the transfer and storage of physical bullion.
“Investors can alternatively invest in gold via derivatives, such as forwards, futures and options. The indirect way to have exposure to gold is through shares of gold mining companies – these appear cheap overall (a price earnings ratio forward at 16), deliver an appealing relative dividend yield (1.8 per cent), enjoy improving
operating margins and have room to improve their return on equity.
Second, Mortier said, gold is a particularly attractive diversifying tool. The golden age of diversification, he noted, is over – the equity/bond return correlation, now in positive territory, will likely gradually revert to neutrality, providing limited statistical comfort.
“Furthermore, portfolio managers are facing a wider variety of risks with uneven timeframes, as a return to the last decade’s normal seems improbable amid scarcer global liquidity, richer valuations and more crowded allocations,” he explained.
“Investors will thus have to rethink diversification, using a broader combination of tools that include relative-value arbitrage, hedge funds’ alpha, tactical trading … and gold, which is likely to play out in the big leagues too.
“The alternative obvious safe havens (the US dollar and the Swiss franc to some extent) are themselves fiat currencies subject to growing defiance.
“Other hedging tools come with strings attached – options and volatility are short term strategies, real assets are illiquid, while cryptos are not mature enough and face key questions regarding supply control and cybersecurity.”
Third, gold offers protection against a wide range of risks regardless of their nature, be it geographic location or timing, provided there is a global fallout (with that being a nice substitute for complex customised hedging strategies).
Importantly, as buy-and-hold investors, including monetary institutions and pension funds, are dominant market players, gold usually tends to price risks long in advance, thus putting less emphasis on spotting the optimal entry point.
Fourth, gold is not only an insurance, but also an investment vehicle.
Inflation-adjusted gold prices are still away from their past highs and gold remains under-owned (less than 5 per cent in diversified allocations, 13 per cent of world foreign exchange reserves, the majority of which are held by debit memo central banks). Additionally, ETF inflows should also resume once rate cuts start.
Mortier said the opportunity cost to hold gold should improve when rates pivot (historically gold jumps around plus 10 per cent) while the embedded geopolitical premium remains mild.
“All in all, gold has further upside potential in our view,” he noted.
“Our fair value models suggest US$2,300 per ounce as an initial milestone and a medium-term equilibrium around US$2,500/oz, which represent our 3 month and 12 month targets respectively.”
Fifth, as most investors are raising their bond allocation, gold could mitigate the higher resulting exposure to fiat currencies.
“Gold is also particularly attractive for non-dollar portfolios, avoiding gold returns being offset by a rising dollar at a time when investors are seeking a safe haven,” Mortier said.
Finally, in relative terms gold is attractive compared to mainstream assets, a majority of which are currently priced for perfection while delivering smaller yields (net of cash and adjusted for risk) than usual.
“Lastly, thanks to its benefits in terms of diversification and hedging characteristics we believe gold deserves a 5-10 per cent allocation within a global diversified portfolio,” Mortier added.
