Gold investing: more than meets the eye

Decalia Asset Management, based in Geneva and founded in 2014, gives views on gold.

Given the number of discussions, articles, and Internet forums on gold investing, it might be assumed that the yellow metal is the most popular asset in everyone’s portfolio.

In fact, the the opposite is true: gold is relatively absent from balanced allocation, with the exception of Switzerland, where the notion of safe haven is still dear to local bankers.

Even institutional investors have often discarded the metal on the grounds that it is a “barbarous relic” with no economic yield.

An inalterable metal with a sheen like no other, gold clearly excites the imagination. But it is first and foremost a universal mean of exchange, which has somehow managed to maintain its value over time. Gold has been valued everywhere throughout history and used to meet survival needs.

The Old Testament, for instance, describes an ounce of gold as worth a year’s supply of food, more specifically 350 loaves of bread, which is still broadly true today! For centuries, gold has shielded individuals against property destruction or confiscation at times of war or revolution.

In peacetime, it is primarily viewed as a hedge against inflation. This explains why it lost its luster in the two decades of disinflation that followed the 1970s.

It returned to favor after 2000, increasing five-fold in a period of low-to-moderate inflation, due primarily to the decline in real rates that began in the US before spreading to OECD countries.

In the absence of war, therefore, real rates are the true driver of gold prices in advanced economies. Gold trading behaves like any other currency.

The precious metal provides no yield, but it appreciates with inflation over the long run, so its value against any currency is a function of the gain, net of inflation, from holding cash in that currency, like any carry cost. In the 1980s and 1990s, aggressive monetary policies imposed positive real rates in an effort to defeat inflation.

Conversely, since the tech bubble, monetary authorities have generally acted to reflate economies so as to generate growth, with a extra push after 2008. That was very supportive for gold.

After the growth scare in summer 2011, the US has returned to a healthy growth path. It was then expected that monetary policies would normalize at some point with higher rates, which led to a 5-year bear market for gold (in USD).

Regardless of whether the US is heading into a recession or not, gold is likely to appreciate in the years ahead. Indeed, Janet Yellen and her colleagues made it clear in their last two committees that monetary policy in the US would favor growth over inflation targeting, even this late in the recovery (despite unemployment at 5%!).

In Europe, the ECB does not seem to be in any hurry to normalize either.

We believe this should be a positive game changer for the yellow metal in the wake of accelerating core inflation, as it lowers the opportunity cost of holding gold.

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