Gold is currently at a three month high and, as one of the more divisive asset classes, this has brought out both the cynics and the gold bugs. One of the reasons perceptions around gold can be so contentious is that there is much discussion as to what drives the gold price and, therefore, its worth within a portfolio.
In terms of the theory, gold is generally perceived to react positively to recession risk, inflation risk, geopolitical risk and, more generally, to elevated uncertainty. Hence, its label as a safe haven.
In practice, looking at how gold has behaved in the past, there is no single answer as to what drives gold and, as with all assets, drivers ebb and flow over time anyway. Nevertheless, there are a number of factors that seem to dominate fairly consistently. For one, the gold price exhibits a negative correlation with the US Treasury real yield. The basic logic behind this is that the lower the real yield on this comparative safe haven, the better gold compares (as a non-interest earning safe haven). Also, gold tends to have a negative correlation with a weaker US dollar: as the US dollar weakens, so gold becomes cheaper in other currencies, and thus a weaker US dollar tends to be positive for gold too. The other key factor that seems to influence gold is the outlook for US rates, where a more dovish Fed should help gold, and, unsurprisingly, these three factors (a more dovish Fed, lower real US yields and a weaker US dollar) will frequently coincide, for example, reflecting weaker economic conditions.
What about the current environment? There has been a general slowing in the economic growth environment, with many of the manufacturing Purchasing Managers’ Indices (a measure of the health of economies) for the major economies heading to, or hovering around, the 50 mark (anything above 50 is considered consistent with expansion and anything below is consistent with contraction). Even the US ISM index, which has a well-regarded relationship with US GDP, and had proved fairly resilient, is now at a 31 month low at 52, while Germany remains the laggard at 44. In short, recession risk has increased.
One of the reasons it has increased is the evolving trade war. Indeed, very recently, there have been a number of new fronts opening up. Last week, the US threatened to impose tariffs on Mexican exports unless Mexico took effective steps to tackle Central American immigration into the US, i.e. linking trade policy to border security. Not only did this illustrate how trade policy could be more broadly weaponised, it also showed how previous agreements could be undone, for example the recently revamped trade deal between US, Mexico and Canada. Unsurprisingly, markets responded negatively. On the same day, the US announced that India would lose preferential access to the US market. And if some investors were thinking it’s just geopolitics, and not politics, the US Department of Justice announced that they are preparing an anti-trust investigation into Google.
So, we have a weaker economic background, escalating geopolitical and political tensions and, partly as a result of this, a more dovish Fed, plus elevated levels of uncertainty more generally. All of these are supportive for gold, though not just gold. It’s worth mentioning that recent weeks have been favourable for risk-off assets generally, for example the Japanese Yen, the Swiss Franc, defensive equity relative to cyclicals and US Treasuries vs US high yield corporate bonds, but it does feel sensible to have gold in the portfolio as one of our current diversifiers.
As for the trade war (cold war), it remains a wild card and, rather than second guessing what might or might not happen, and the relevant timings, we retain a fairly defensive portfolio, with a bias to US equities, long duration US Treasuries, a basket of property stocks, an elevated cash position and, of course, some gold.
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Source for information: Miton as at 05/06/2019 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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