Gold's place in a portfolio

Spotlight: Gold

There has been a lot of interest recently in investing in gold in portfolios particularly with the price of gold recently reaching record highs. But before you rush to fill your portfolio with gold, let’s take a closer look at whether it truly shines as a wise investment choice.
 
Gold is a unique and valuable asset with several key characteristics which we outline below:

• Some investors like gold as it represents a store of value. But, unlike equities (which can pay dividends) or bonds (which can pay interest) gold does not provide investors with income. In the current market environment, where interest rates have risen above 5%, holding gold becomes less attractive because an investor has to forgo interest income received from holding lower risk assets like cash and bonds.
• Gold is a finite resource and with a relatively stable level of supply therefore, demand tends to be the main driver of price.
• Gold is often considered a "safe haven" asset which means that many investors buy gold during periods of extreme market stress or heightened geopolitical uncertainty such as regional conflicts or wars.
• Although gold is often thought of as a hedge against inflation, historical data since the 2000s suggests that the relationship between gold prices and US inflation has been weaker than is often claimed.
• The value of gold can change very quickly, and is more likely to experience periods of unpredictable and sometimes sharp price movements than other assets which play a similar role in the portfolio like government bonds. 

Over the past couple of years, the price of gold has risen to record highs driven partly by an increase in demand particularly from emerging market countries such as Russia and Turkey who have been buying gold to support their currency and reduce their reliance on the US dollar. The increase in central bank holdings is difficult to predict with much confidence given it’s more a consequence of recent market environment/geopolitical events, rather than something with a longer-term fundamental basis. There is generally an inverse relationship between bond yields and gold, i.e. when bond yields are high, gold gets less attractive as they are effectively substitutes and vice versa. In this most recent rate rise environment we didn’t see that relationship play out (see chart below) i.e. gold prices didn’t fall, so US inflation linked government bonds for example, looked better value economically.

The market trends of the past two years haven’t materially increased gold’s ability to be a good inflation hedge nor a downside protection asset when allowing for the context of the longer history. One of the key reasons that investors allocate to gold is because it is often considered to provide protection benefits to investors in certain environments when other assets tend to underperform, for example when inflation is high the price of gold tends to rise. However, there are other alternatives to gold that provide similar protection but with less risk. For example, high-quality US government bonds or inflation-linked bonds which help protect against inflation and market downturns, but unlike gold, they provide regular, stable income for investors. Bonds can also be accessed more cheaply than gold. Other alternatives are infrastructure and real estate companies which also tend to perform well when inflation is high. At present, such alternatives may provide more robust protection and deliver better long-term performance than could be achieved through an allocation to gold in our view.
 
We are in some ways contrarian with our current view not to allocate to gold. We regularly review the case for assets such as gold and some reasons we may look to allocate to gold in the future would be:

• A change in the relative attractiveness between gold and similar asset classes e.g. if gold falls in price
• A view that the demand/supply dynamic that has propelled gold values in the last year will continue meaningfully
• An increase in the likelihood of negative market outcomes meaning we want more protection in our portfolios (combined with gold) if it is expected to provide the type of protection we are looking for

The Noise

• The Eurozone has experienced positive growth, noteworthy for a bloc that has been on the brink of recession for nearly a year. Although the growth remains slow, it can be attributed to an expansion in industrial output, which increased by 1.8%. This contributes to the overall, albeit gradual, recovery of Europe’s economy. This is bolstered by the European Central Bank (ECB) cutting interest rates in back-to-back meetings, for the first time in 13 years. With inflation now below its 2% target, they can be more comfortable with cutting rates in future meetings. This marks a significant shift for the ECB, moving its focus from controlling inflation to prioritising the protection of economic growth in the Eurozone. As these measures take effect, there is some hope for a more robust recovery of the eurozone’s economy in the coming months.

• The UK job market remains stagnant, with the unemployment rate sitting at 4%, which equates to around 1.39 million people looking for a job. Job advertisements are declining, and competition for available positions is fierce due to a slowdown in hiring. Graduates face especially tough conditions, with roughly 140 applications per entry-level position this year. Sectors like IT, finance, and professional services have seen the largest declines, with vacancies down by 5-35% compared to last year. Geographically, London has experienced the sharpest drop, with a 22% decrease in job openings, which is concerning as it accounts for one-third of all graduate roles. This slowdown in hiring is linked to an uncertain economic outlook, with forecasts predicting only a 1% rise in vacancies over the next year. Even those currently employed are feeling the effects, as pay growth is at its weakest since February 2021. Looking forward, with interest rates returning to normal levels, we could anticipate some stimulation in the job market which might improve the current conditions.

• This week, major US tech companies made significant investments in the renewable energy transition, signalling a shift toward nuclear energy. Google has partnered with Kairos Power to develop seven small nuclear facilities aimed at powering its AI data centres, with plans for them to be operational by 2030. In a similar vein, Amazon has committed $500 million to support the US nuclear energy developer X-energy. These substantial deals reflect the growing need for new energy sources to support the high-power demands of AI technologies, which require substantial electricity for data centre operations. By turning to sustainable solutions like nuclear energy—characterized by zero carbon emissions—these US tech companies are paving the way for the commercial implementation of nuclear power over the next decade. There could be an unrealised potential of AI, to power our transition to more sustainable energy sources.

The Numbers

The Nuance

UK inflation rates declined more than anticipated to 1.7%, in September. It was the first inflation rate reading below the Bank of England’s 2% target in over three years, April 2021 being the last such instance. This comes alongside data showing lower wage growth, indicating that the record-high inflation rates we have experienced over the last few years may finally be settling after an extended period of price growth.

UK inflation rates falling below expectations is a good sign, it shows inflation is cooling faster than expected after the soaring rates we’ve seen over the past three years. It is also positive to see ahead of the much-anticipated budget later this month, giving Rachel reeves a little bit more leeway in what is promised to be a ‘tough’ budget for taxes.

Tangibly, one will experience the effects through lower airfares and petrol prices, which were some of the driving forces behind lower than anticipated inflation rates. So, the next time you take a holiday or road trip it may feel more affordable compared to recent years.

This is bolstered by the annual increase in consumer prices being lower than the 1.9% forecast and that British retail sales grew for the third month in a row by 0.3%. In essence, we anticipate a boost in consumer confidence and spending in the lead up to Christmas.

In terms of direct fiscal impact, this has resulted in the pound falling; figures released this week have seen the pound down 0.6 percent against the dollar, at $1.30. However, the pound has continued to rise versus the Euro, reaching its strongest levels since April 2022. With all of this in mind, traders have been hedging their bets of further Bank of England rate cuts before the end of the year. They have two more meetings in November and December, with any additional cuts benefiting consumers through falling borrowing costs and mortgage rates.