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How should selectors view gold as macro outlook darkens?

A challenging combination of low government bond yields, uncertainty around US-China trade relations and a weakening US dollar justifies an allocation to gold in client portfolios, according to Stéphane Monier, CIO at Swiss bank Lombard Odier.

Gold’s traditional role in a portfolio has been as a hedge against inflation and equity market volatility, and as a diversification tool. This year, a combination of factors has driven gold to six-year highs. After trading around US$41,300/oz over the first five months of this year, gold rallied 8% in June and finished the month at US$1,410/oz. The precious metal is now trading at US$1,426/oz.

Gold price (one-year performance)

These factors include expectations of lower interest rates in the US, a weakening US dollar and rising geopolitical risk in the form of US-China trade and tensions with Iran in the Gulf. In addition, uncertainties around the late economic cycle and widespread negative yields have all encouraged investors to look for alternative havens.

“It’s worth reminding ourselves that gold trades for the most part on financial demand, rather than on fundamentals. A big driver of financial demand is fear in financial markets, which is why gold often acts as an effective hedge against volatility,” Monier said.

A role in multi-asset portfolios

As the effectiveness of government bonds as a hedge decreases with the level of yields – the potential for lower yields is more limited when bonds are trading in negative territory – holding gold in multi-asset portfolios is becoming more necessary, Monier argues.

“The additional financial demand induced by the lack of safe haven assets is likely to limit downside risk, and given the already exceptional length of the cycle, we can expect recession fears will periodically re-emerge,” he said.

Monier said that a negative correlation between gold and equity should not be taken for granted – gold’s annualised volatility has historically been comparable to equity volatility.

“Adding gold to a multi-asset portfolio usually means adding to the overall portfolio risk, which is why it’s key that this allocation is tactically managed,” he said

One recent notable occasions gold did not protect portfolios against equity drawdowns. In the financial crisis in October 2008, for example, both gold and US equities dropped around 20%. However, Monier points out that gold quickly attracted flows again and recovered losses, gaining almost 35% when equity markets fell another 30%.

“Gold has always been thought of as the ultimate hedge against financial instability and any loss of confidence in financial and monetary institutions,” he added.

Shift from cash to gold

Monier continued: “Since the financial crisis, accommodative central bank monetary policies have bailed out the financial system with two negative consequences. First, they have exacerbated social inequalities by benefiting most those able to invest and take advantage of the lower cost of money and rising asset prices. That disparity, in turn, has led to an increase in populist politics, undermining political stability.

“Secondly, the global economy’s greater dependence on unconventional monetary policy and inflated central bank balance sheets threatens confidence in the financial system itself. If the next stage in monetary policy fails to improve economies sustainably, investors may turn away from cash and towards gold,” he said.

“We expect the combination of low government bond yields, uncertainty around US-China trade relations and a weakening US dollar to stay with us in the months to come. This is an environment supportive for both gold prices and gold’s effectiveness as a hedge.”

David Robinson

David Robinson is the editor of Expert Investor. He has 18 years’ experience as a business journalist and editor. In the past he has written for the Guardian newspaper and The Telegraph, and worked as...

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