Focus on gold: Gold should be thought of as a currency, Pimco
Gold valuations are not as stretched as a naïve look at its nominal price might suggest, according to Nicholas Johnson, portfolio manager at Pimco focusing on commodities.
Last week, gold prices reached a 1-month high of $1,796.50 an ounce after ECB’s President Mario Draghi suggested that more bail-out could be announced by eurozone countries over the next weeks.
Gold price also gained by surprise fall in the US unemployment rate to 7.8% in September from 8.1% in August.
“Central banks globally are seeking to depreciate their currencies in a beggar-thy-neighbor attempt to stimulate their domestic economies. Therefore, we believe investors should consider owning gold, precious metals and other assets that store value as long as central banks continue to print and maintain negative real interest rates,” Pimco said.
Johnson added that investors should consider allocating gold and other precious metals to a diversified investment portfolio.
“The supply of gold is constrained, and we see demand increasing consistent with global economic growth on a per capita basis. Regarding inflation in particular, we feel that the Federal Reserve’s decision to begin a third round of quantitative easing makes gold even more attractive,” he said.
The Fed’s actions in the wake of the financial crisis as a paradigm shift whereby the Fed is attempting to ease financial conditions and encourage risk-taking by increasing inflation expectations.
“Its policies will likely result in continuous negative real interest rates because nominal rates will be fixed at close to 0% for the foreseeable future,” he said.
But, the manager added, gold isn’t the only asset with the potential to hold its value in inflationary times. Treasury Inflation-Protected Securities (TIPS) offer an explicit inflation hedge and tend to be less volatile than gold.
“Still, history shows that gold is highly correlated to inflation and has unique supply and demand characteristics that potentially lead to attractive valuations,” he said.
The downside of gold is that it generates no interest.
“One ounce of gold today will still be only one ounce next year and the year after that,” the manager warned.
Because of this, gold is sometimes referred to as a non-productive financial asset, but Pimco feels this characterization is misleading: “Rather, we believe gold should not be thought of as a substitute for equities or corporate bonds. These have equity or default risk and therefore convey risk premiums.”
Instead, gold should be thought of as a currency, one which pays no interest. Dollars, euro, yen and other currencies can be deposited to receive interest, and this rate of interest is meant to compensate for the decline in the value of paper currencies via inflation. Gold, in contrast, maintains its real value over time so no interest is necessary.
The forward-looking return on holding US dollars, and most other major currencies, has been artificially lowered by the Fed’s commitment to keep interest rates pegged at near zero for the next few years; real yields on US government bonds are negative out to 20 years.
“In such a world, we believe the desire and willingness of investors to hold gold relative to other currencies increases dramatically, creating the potential for continued price appreciation,” Pimco said.