Overview
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Gold as a safe haven
Our view on the drivers of the gold price go beyond gold’s long-held status among investors as an attractive safe haven in times of market stress or as ballast to offset riskier positioning. Underpinning our thesis on gold are three drivers: the state and direction of real rates, the strength or weakness of the US dollar and overall risk sentiment.
The first leg of the thesis, the state and direction of real rates, has been a contributing factor to the strong performance of the gold price in recent months, with the price of gold and real rates having a relatively strong negative correlation over time. Gold is not a yielding asset, which means that when yields are high there is a significant opportunity cost involved in holding gold. But in a low interest rate environment (like we are in today) the opportunity cost declines significantly. This factor may still have some room to run if the US Federal Reserve’s 25 bps rate cut in July heralds the beginning of a more sustained cutting cycle.
Gold tends to do less well when the US dollar is strong and appreciating. Real rate expectations have changed significantly over the course of 2019. We started the year with markets pricing in 75 bps of hikes but have now shifted to about 100 bps of cuts. Given this environment, the US dollar should have fallen and helped support the gold price, but this has not been the case. We see this component of our thesis on gold as still in play. The strong dollar has been largely driven by US ‘exceptionalism’ in the form of tightening policy and stronger economic growth. But with the US economy ‘catching down’ to the rest of the world and the Federal Reserve returning to dovishness, we think the US dollar should begin to weaken, creating a tailwind for gold.
Source: Refinitiv, Fidelity International, August 2019
Sell-off
Overall risk sentiment, the most commonly thought of driver of the gold price, is another leg of our thesis that has not been supportive until recently. Risk assets such as high yield credit and equities have been performing strongly in recent months, pricing in dovish monetary policy rather than weak fundamentals. As risk assets have sold off in recent days, we believe that gold’s status as a traditional safe haven will continue to support the price or even drive it higher.
When allocating to gold, investors need to be mindful of the overall objectives for their portfolio. For example, investors willing to take on more risk may wish to have a higher allocation to the equity securities of gold mining firms, which are exposed to the gold price and equity market risk. Physical gold, on the other hand, may attract a higher allocation in more defensive portfolios and is not exposed to equity market risk. We are also tactical in adjusting our exposures based on the valuations of gold mining stocks, meaning that we look at whether they implicitly price in a higher or lower gold price than today’s spot price.
Markets are undecided on whether to focus on easing monetary policy or declining growth. Against such a backdrop, we maintain our focus on capital protection and being highly selective in our exposure to risk assets, carefully balancing both downside protection and upside participation. With the primary drivers of the gold price still very much in play, this position remains supportive of these objectives.
