InvestmentsSep 29 2014

Rising political risk could lure investors

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The macroeconomic environment and the outlook for the geopolitical landscape will often dictate whether investors flock to perceived safe haven assets such as gold.

Geopolitical tensions have been escalating in recent months in Ukraine and Russia, as well as in the Middle East, while the Scottish referendum created some uncertainty in the markets.

Meanwhile, central banks continue to diverge when it comes to monetary policy.

In spite of all these factors, investors have turned their backs on precious metals, leaving gold out in the cold.

In September, the price of gold hit an eight-month low, following an announcement from the US Federal Reserve that suggests interest rates are likely to remain low until some time after quantitative easing comes to an end in October this year, and then rise at a faster rate than expected from 2015.

Chris Beauchamp, market analyst at IG Group, warns that precious metals will remain under “serious pressure” amid rising demand for US Treasuries and the dollar.

He observes: “If there are two elements driving precious metals, it will be the lack of reasons for a ‘flight to safety’ and the seemingly unstoppable rise of the US dollar.

“The Ukraine situation, with its threat of heightening tensions between Russia and the west and the possibility of actual conflict between Moscow and Kiev, was providing a near-constant bid to the gold price.

“That has now been removed, and the reaction has been predictable. Investors have lost their one strong rationale to hold precious metals as an asset.”

Instead, the search for income has won out over the hunt for a safe haven in the current climate.

Mr Beauchamp adds: “Faced with an asset designed to provide safety in emergencies, and ones that provide a yield, most have sensibly chosen the latter and outflows from gold exchange-traded products confirm this.”

Jason Hollands, managing director of Bestinvest, says the price of physical gold has so far failed to “stage a convincing bounce back this year”.

He notes: “Given interest rate rises are widely expected in both the US and the UK after five years of record-low levels, this could suggest it makes sense to be cautious on gold.

“The prospect of rising yields on bonds is further reason why investors might be sanguine on gold. As a non-productive asset, gold has a zero yield, so there is an opportunity cost to holding it.”

For some investors, the prospect of further geopolitical risk may tempt them back into precious metals and commodities, though.

Tom Elliott, international investment strategist at deVere Group, argues that a small exposure to precious metals could protect against global political tensions.

He says: “There seems to be a growing disconnect between investment and global political tension. Russia is at war with Ukraine, the Middle East is engulfed in a Sunni/Shia conflict on multiple fronts and China is testing the resolve of its neighbours to defend their maritime borders, among other situations.

“All are challenges to the west to defend its interests, and on all scores the west is hesitant to intervene.

“Yet real assets, such as commodities, particularly oil and gold, have barely responded to the rise in geopolitical risk this year.”

Mr Elliott adds: “If classic monetarist theory proves correct, inflation will eventually follow on from the quantitative easing programmes, and all commodities – especially gold – will be in strong demand as investors seek to protect their portfolios.”

Mr Beauchamp is less positive about the prospects for precious metals as an asset class against the global economic backdrop.

He reasons: “Commodities in general had a good first half, but as we head into the fourth quarter the class is out of favour.

“As the first US rate hike in years gets ever nearer, the dollar’s appeal is only going to get stronger.”

Ellie Duncan is deputy features editor at Investment Adviser