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Written by: Darius McDermott
13/08/2020
Having topped $2,000 an ounce for the first time ever in early August, gold is the asset class of the moment, as investors look for a safety-first option to tackle the ongoing market uncertainty.

Gold is typically the place to be going into a crisis, due to its defensive qualities and lack of correlation to equities and bonds. However, what we don’t know is whether we are coming out of a crisis or still firmly in the midst of one.

Having risen more than 20% year to date – after a similar increase in 2019 – some commentators are starting to talk about a bubble in the yellow metal. With this in mind, we thought we’d look at some of the pros and cons of the asset class and what may lie in store.

How high can the price of gold go?

Despite hitting record highs, the case for the gold price continuing to rise is actually quite a strong one. For example, we’ve seen $2trn of new money printed in the past few months of the year, as central banks globally look to provide a coordinated and quick fiscal response to the global lockdown.

Normally, this unprecedented level of monetary stimulus should be inflationary, but that is not the case on this occasion, and I feel that is unlikely to change for the next 12 months or so. It has also failed to de-value the existing money in the system – which could also improve the price of gold.

Another factor is based on a note I read from Schroders, which highlighted the position of gold now versus its previous high in 2011. Some of the principal differences included gold not being as widely held in investor portfolios or in exchange traded funds (ETFs), while the nature of its price rise in 2020 is totally different to 2011, when gold surged around 15% in the month before its peak.

The ETF exposure is one area of particular importance. According to Schroders, only 2.5% of total ETF holdings globally are currently in gold (vs. 10% in 2011). However, the upsurge has been quite aggressive with 643 tonnes added to physical gold ETFs so far this year, comparing to 372 tonnes added in all of 2019 (the record is 665 tonnes in 2009).

Reasons to be cautious

While gold tends to be uncorrelated to the performance of other assets, like equities and bonds, that is not always the case during periods of significant market stress when every asset can fall.

The other factor is how long do you hold gold for? One of the best ways to make money from the stock market is through re-investing dividends back into your holdings. Gold does not yield a dividend; it simply goes up and down in price. That may be attractive when bonds and equities are not offering attractive dividends, but that will not last forever.

In summary, I think it’s not unreasonable to see a further price rise for gold, but perhaps not to a significant degree from here. These are strange times and some of the rules that typically apply to markets have really gone out of the window. It’s understandable why investors may seek a safe haven with so much bad news out there – but the tipping point between paying too much for an asset that does not pay a long-term dividend could make this a risky play for those investing large sums at this point.

Gold fund ideas

A good specialist option for investors is the Merian Gold and Silver fund, managed by Ned Naylor-Leyland. The portfolio’s neutral position is 50:50 gold/silver, but Naylor-Leyland will manage the mix, adjusting the relevant weightings according to his view of the world. Naylor-Leyland will also move the portfolio between bullion and miners depending on his macroeconomic view and valuations. In a more defensive scenario, the fund will own more bullion and more gold.

Those who are more cautious may prefer a multi-asset fund, such as the VT Seneca Diversified Income fund, which has a 7% exposure to gold. The Jupiter Merlin Growth fund has more than 10% in the asset class courtesy of two ETF holdings and exposure to the BlackRock Gold and General fund.

Darius McDermott is managing director of Chelsea Financial Services and FundCalibre

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