Photo: Bloomberg LP
Gold is shiny, but ultimately useless. At least that’s what skeptics say about the role of the precious metal as an investment, stressing the lack of any revenue from its retention.
However, in global financial markets, zero income can sometimes seem attractive, writes Tommy Stubington in an analysis for FT.
Currently a debt of about 15 trillion. The dollar has zero yields, including the US debt market, one of the last bastions of positive yields among highly rated government bonds, taking into account inflation.
The declining return on investment in the debt markets is one of the reasons why the price of gold broke new records, said Stubington. It also reduces the attractiveness of bonds as a refuge that undermines the traditional “60/40” scheme for investors.
The 60/40 portfolio theory predicts that 40% of it should be investments in bonds to mitigate a possible decline in equities. With negative returns, however, against the background of loose central bank policies, this logic seems more uncertain. Bonds don’t seem to have much room to rise in the event of a stock market sell-off.
It is therefore no surprise that investors are turning to new ways to offset the risk of investing in stocks. For many, such an option is gold.
“We’ve had a lot of questions from clients who are interested in gold for hedging equity investments,” said Dario Perkins, managing director of global macro research at TS Lombard. According to him, these studies started last year due to the widespread distribution of securities with negative yields and are now intensifying due to the coronavirus crisis, because the large-scale purchase of securities from the Federal Reserve contributes to reaching new lows.
Many investors are aware that the negative relationship between bonds and stocks is not an iron law of finance, but a relatively recent phenomenon. Prior to 2000, the markets for fixed income instruments followed the upward and declining trends of the stock markets.
Still, for those switching to gold as their preferred hedging tool, there is bad news. The bar record as a negatively related asset is also brighter than bonds.
Dario Perkins, who has been looking at data for a century and a half, says gold sometimes offers a useful alternative, but is more often positively associated with stocks at the same time as bonds.
Only during bouts of high inflation – most recently in the 1970s – did gold provide a counterweight to equities, while fixed-income instruments failed. More normal is the kind of relationship seen in March this year, when a brief but sharp sell-off of gold took place in the midst of the stock market carnage.
However, the return of inflation after decades of a slow rise in prices is exactly what many gold buyers are positioned for. Governments around the world are issuing record debt, and central banks are buying bonds at a brisk pace, in part in an attempt to curb borrowing costs. If the global economy quickly shakes off the effects of Covid-19, it will bring back growth and inflation, but central bankers are unlikely to rush to withdraw incentives.
Analysts at Goldman Sachs point to the Fed as a potential change “towards inflation bias” when they increased their 12-month price for gold by $ 300 to $ 2,300 an ounce.
Bank of America points to another link between bond markets, gold and the threat of inflation. Michael Hartnett, an investment strategist, recently wrote that buying bonds from central banks is hampering investors who might otherwise be betting on higher inflation by selling or cutting government debt. Instead, they turn to the gold trade en masse.
It is worth remembering that in the past, investors have lost on bets on rising inflation. After the recent financial crisis, many speculated that unprecedented levels of monetary stimulus would trigger a wave of rising prices. Instead, a decade of very low inflation followed.
Many bond investors seem to have learned this lesson. Although recent declines in real yields are the result of rising inflation expectations, levels remain low by historical standards. The US price expectations indicator, which measures the difference between the yield on regular and inflation-protected bonds, is currently 1.5 percent. Markets expect an even lower rate in Europe.
In part, this reflects the distorting effects of quantitative easing. However, many investors are skeptical about higher inflation, not least because the shock of the coronavirus has also affected the demand of many large economies looking at the possibility of a direct drop in prices.
In order for gold to prove its value – either as a portfolio stabilizer or as a long-term instrument for hedging inflation, bond markets will have to turn out to be on the wrong track.