Economic anxiety sustains gold rush

Investors are scrutinising each pronouncement by the US Federal Reserve, as the Fed carefully monitors data points on the US and international economies.

Despite a strong rebound in US non-farm payroll data in June following a weak reading prior to that, interest rates were held steady in July in part because of the UK’s Brexit vote in the EU referendum, which has reduced global growth expectations.

In this environment, many investors are holding high levels of cash on a historic basis. Against this backdrop, asset classes seeing real investor conviction have been few and far between, year to date.

Looking at exchange-traded product (ETP) flows, gold is one of the few asset classes that has been gathering assets consistently this year. This was particularly evident during the market falls at the start of the year, with gold seeing a correlation with the US equity volatility index – the Vix – rising to eight-year highs.

As well as gold representing a traditional store of value in uncertain times, a far more ‘dovish’ trajectory of interest rate rises from the Fed than had been expected at the start of the year seems to have boosted interest in gold.

Following the high level of gold ETP purchases recorded in January and February – and the abating of such interest in favour of more risk-on themes in March and April – in May, global ETP investors showed a renewed and marked preference for gold and fixed income investments over equities.

After strong inflows into gold in May, flows continued into physical gold funds, as well as gold mining ETPs, in June, attracting another $5.4bn (£4.1bn). This brought the total flows into gold ETPs to $22bn in the first half of 2016.

This is a new annual record – with six months of flows still remaining to be tallied up for 2016. The previous high for global gold ETP inflows was $17bn during 2009. Elsewhere, at mid-year, fixed income flows remained poised for a record year.

As well as gold representing a traditional store of value in uncertain times, a far more ‘dovish’ trajectory of interest rate rises from the Fed than had been expected at the start of the year seems to have boosted interest in gold and its price has risen accordingly – above $1,310 per troy ounce at one stage.

Looking ahead, with the potential for US inflation to rise, gold may remain popular as it has often been viewed as an inflation hedge – with varying degrees of effectiveness. This theory could be tested again soon, given that there has been a pick-up in US inflation metrics, such as the consumer price index.

More broadly, a range of political issues is likely to contribute to uncertainty in the second half of the year, including ongoing concerns about the global growth outlook – particularly if the US economy falters. Compounding that is the possibility that investors may lose faith in the effectiveness of central bank policies, such as quantitative easing.

Hedging against volatility is likely to remain relevant in a portfolio context. Investors could still consider a strategic holding in gold, even though its price has already risen strongly year to date, because of its safe-haven qualities and, as is the case with many alternative assets, it does add diversification to a portfolio.

iShares recently carried out analysis on alternative investments to see what could be a good diversifier and be beneficial from a risk and return perspective within a portfolio.

As an example, for a standard 60 per cent/40 per cent equity and fixed income asset allocation over a time frame of the last eight years, the research found an optimal combination of gold and broader commodities exposures reduced the overall volatility of the portfolio, while a combination of gold and other precious metals produced a more efficient portfolio overall with both lower risk and higher returns.

The analysis showed the advantage of alternatives exposure in this portfolio where gold and broad commodities were the greatest diversifiers from a historical perspective.

Despite its progress in performance terms in recent months, gold seems likely to remain a popular trade because of its diversification status and, potentially, its risk and return benefits.

Ursula Marchioni is chief strategist EMEA for iShares at BlackRock