Multi-manager  

Gold’s sparkle begins to fade

In early 2013, I sold my holdings in the yellow metal, based on statistical indicators that were consistent with my view that the US dollar would strengthen. I believed this strength would be based on a better US consumer and macro backdrop; as key indicators of global economic growth start to recover, quantitative easing expectations should fall, and thus investors owning gold should reduce their holdings, driving the price down sharply. Crucially, the ‘safe haven’ status afforded the asset class by many investors was under threat of revision. This has proved to be the case.

I remain mindful that gold’s correction from more than $1,850 (£1224) at its peak to just below $1,200 (£794) at its trough is part of a natural process in an extended bull market. I believe it is an asset best avoided for the moment, as investors liquidate positions en masse. If we see gold retrace closer to $1,100 (£728) I am likely to re-examine the investment case.

In the short term I do not hold gold positions; investors who wish to protect their portfolios from the risk of inflation using an alternative to gold might consider land, property or other real assets. Alternatively, index-linked bonds or senior secured loans may provide some protection should inflation spike. In the fixed income arena, with an improving European outlook and the huge stimulus package by the Bank of Japan, peripheral bonds look very attractive to yield-hungry investors. However, I still prefer to take exposure in quality European mortgage-backed securities and loans, thereby removing duration risk.

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Multi-asset investors invest in gold for a variety of reasons. This multifaceted approach to investing in the yellow metal, combined with the difficulty in valuing it, make it notoriously problematic to predict price movements. Assets whose prices behave in this manner typically attract momentum style investing and can experience sharp rises (or falls) in short periods of time, much like the internet stocks during the ‘tech boom’ in the early noughties, and more recently the ‘Bitcoin’ phenomenon.

The key drivers of the gold price in the past decade have been associated with fear and greed. Investors have flocked to gold as a hedge to protect against US dollar weakness, as well as a potential rise in inflation – a concern that has been exacerbated in recent years as central banks have primed their printing presses for bouts of monetary easing.

Greed has been another motivating factor, as speculative investors have gravitated toward the asset class, viewing the increasing price levels as an opportunity to capitalise on momentum. This bandwagon investing can buoy prices in the short term, and more worryingly, can also lead to a self-fulfilling prophecy phenomenon, where the values attributed to the precious metal, such as those described above, become widely accepted. In fact, recent studies such as that by Erb and Harvey from the US National Bureau of Economic Research, have shown that gold is an ineffective hedge against inflation. Their study, citing data from as far back as 1970, the beginning of the previous gold bull market, shows that correlations between CPI indices (inflation indices) and the price of gold have fluctuated wildly.

What is crucial, when investing, is to appreciate that investor perception must be taken into account. We should consider what investors believe about gold alongside an assessment of fundamental valuation. Warren Buffett, the US private equity investor, has famously rubbished gold as an investment.