Gold has proven its mettle for long-term investing

The yellow metal was one of the few to produce a positive return (1.3 per cent), but this was comfortably below expectations as inflation, rate hikes, falling demand in China and a strong dollar all put pressure on what is often seen as the safe haven asset in an uncertain economic environment.

We are now at an interesting point in markets for the asset class. Having risen around 19 per cent since October, gold is currently around $1,920 (£1,585) an ounce, meaning the asset class is around 5 per cent off its all-time highs, with many analysts predicting strong performance throughout 2023.

There are reasons for that optimism: real rates are likely to have peaked, with any fall likely to bring a higher gold price; the dollar has also started to weaken; while the ongoing war in Ukraine maintains gold as a useful risk-off hedge against inflation.

As inflation begins to fall, we are also seeing some of the scary scenarios by central banks being taken off the table.

However, others would point to the changing economic environment, making gold less attractive compared to asset classes.

You are now giving up a lot of yield buying gold versus fixed income. The reality is that the bond market may appear a more attractive alternative to investors at present, particularly with US two-year treasuries well above the 4 per cent mark. 

You could also argue that investors will get more upside exposure in other asset classes if rates fall back. As inflation begins to fall, we are also seeing some of the scary scenarios (and possible mistakes) by central banks being taken off the table. It makes for something of a conundrum for investors – particularly over the short term.

Changing your perception of gold

Jupiter Gold & Silver fund manager Ned Naylor-Leyland says one of the big mistakes investors make is comparing gold to currencies – in reality the gold price never changes, but the value of currencies relative to the asset class does. As a result, the price of gold never goes ‘up’, rather certain currencies depreciate at a faster rate against it.

You have to look at gold from both a short and long-term perspective in the current environment.

He adds that the rate of this depreciation is not only influenced by the relative strength of the currencies, but also external factors such as gold reserves, jewellery demand and market volatility.

This, in a nutshell, is how central banks view the asset class, which helps understand some of their decisions.

He says: “We have recently seen that central bank purchases of gold are the strongest in the past 25 years. This points towards a fraying of trust towards the safety of traditional currencies. According to the World Gold Council, central banks’ gold purchases have reached 673 tonnes in 2022 alone – the highest level since 1967.”

Naylor-Leyland says the reasons for these significant purchases are two-fold. Firstly, because market/geopolitical uncertainty has led them to increase stockpiles of gold – reaffirming its position in periods of political uncertainty – and secondly, because it remains a long-term hedge against inflation.

Ninety One Global Gold fund manager George Cheveley says investors should take note of the fact that the 50-year-plus high in central bank purchases includes the Chinese, which have started reporting increases in the gold reserves for the first time since 2019.

He sees this as a desire by central banks to diversify away from USD/USD treasuries, in particular by China as US sentiment has worsened towards them.

Gold has proven its recession resilience

The inverted US yield curve continues to stand out as the main pointer to a recession for the global economy (it has been correct every time for the past six decades). So how will gold and gold equities manage should this continue? 

Research from Schroders shows that in the past seven recessions gold and gold equities have done well in absolute terms overall (up 28 per cent and 61 per cent respectively) and relatively to the S&P 500 (up 37 per cent and 69 per cent respectively). The only occasion the asset class fell was during the Volcker recession of 1981 and 1990. 

Schroders says one of the reasons they are structurally positive on gold is that they believe, given extremely high sovereign debt levels and large deficits, any repeat of a Volcker style intervention would quite likely lead to systemic financial collapse.

Positives for gold equities too

Last year was also difficult for gold equities as gold producer margins got squeezed between rising costs (oil, steel, labour) and falling gold prices. The 5 per cent rise in the gold price year-to-date (as markets look to predict a move down in rate hikes in tandem with dollar weakness) has also begun to benefit gold equities, which are leveraged to the gold price and have risen 13 per cent as a result.

Cheveley says lower energy prices in recent months should help cost control at companies as well, with margins improving from lower costs and higher prices. He says the underperformance of gold equities in 2022 means the lessening of any headwinds should provide a meaningful bounce.

With more uncertainty and possible recession in our midst – the long-term argument for gold remains as strong as it has ever been.

You have to look at gold from both a short and long-term perspective in the current environment. The wider expectation is that, at some stage, the US will reverse their policy of rate hikes as inflation falls back – creating a more attractive environment for the asset class.

Corporate earnings downgrades in many sectors may also drive volatility and push investors towards gold as a safe haven.

I can see why income-hungry investors would want to cut their gold exposure in the current climate, but with more uncertainty and possible recession in our midst – the long-term argument for gold remains as strong as it has ever been.

Investments to consider

Jupiter Gold & Silver invests in both physical gold and silver bullion, as well as gold and silver mining companies. The fund’s neutral position is 50:50 gold/silver. The portfolio is very sensitive to geopolitical risk and typically avoids mining companies that invest in dangerous parts of the world.

Ninety One Global Gold is a concentrated fund investing in gold mining companies. The manager says that gold equities offer leverage to the gold price, so if you believe in gold you are better off owning gold equities. In addition, unlike physical gold, many gold miners pay a dividend and these payouts have been rising in recent years.

BlackRock World Mining trust has significant flexibility to invest across various metals and mining companies, including unquoted companies. It has a conviction-led approach to investing in the mining sector, as opposed to focusing on the short-term direction of commodity prices. The trust currently has a 12.4 per cent allocation to gold. 

Darius McDermott is managing director of Chelsea Financial Services & FundCalibre