With volatility returning to markets and inflation on the rise, we ask whether newer asset classes offer more protection for investor wealth.
When everything else is falling, it’s widely believed that gold is the place to put your money.
Market volatility is higher than the recent past and inflation is on the rise, so it’s not surprising that gold is appearing on investors’ radars once again. At Coutts, however, we don’t currently hold any gold in our portfolios and don’t think it’s time to turn to it just yet.
Rings and things
One of the big problems with gold is the complex factors that influence its price.
The gold supply is limited and relatively static. There are approximately 190,000 tonnes ‘above ground’ according to the World Gold Council, equivalent to a cube measuring about 21 metres on each side. Mining adds about 2,500 to 3,000 tonnes a year. By contrast, central banks can create cash – or remove it from the system – at their discretion, and manipulate its value through interest rates.
The demand side for gold doesn’t seem to have much influence on the price though.
Jewellery has historically been the biggest market for it, currently accounting for about 50% of demand. China recently overtook India as the world’s biggest market for jewellery having seen a huge growth in demand, up from about 224 tonnes in 2004 to 669 tonnes in 2013. But generally, demand for jewellery has been declining in recent decades.
Use in industry, pharmaceuticals and – especially – electronics has been rising slowly, and now accounts for about 10% of demand. However, prices don’t respond to economic conditions in the same way as other commodities with widespread industrial uses, such as copper, oil, silver or platinum.
Investor demand has become the key driver for gold prices, rising by about 235% in the last 30 years, and now amounts to about 30% of global demand. Gold prices tend to rise as investors seek its use as a safe haven, and fall as investors sell out. Gold seems to act best in times of extreme systemic risk. In the 1970s, when US inflation was in double digits, gold prices rose 18-fold, and in the year after the collapse of Lehman Brothers in 2008 it went from $700 an ounce to $1,054 an ounce.
The main trigger for investors to buy gold appears to be sharp falls in ‘real’ interest rates, usually as a result of sudden rises in inflation. The ‘real’ interest rate equals the government base rate minus the rate of inflation and reflects the real return on money held as cash. So, if inflation rises to 8% and the base rate is 1%, the real interest rate is -7%. In this circumstance, parking your money in a government bond will see it lose 7% a year in buying power.
Sudden spikes in inflation are also associated with the types of economic disturbance that can increase equity market volatility. And when cash and equities both look risky, investors will see gold as a better way to maintain the value of their investments.
While inflation is on the rise, we’re not currently seeing a substantial fall in real interest rates as central banks are generally raising rates. Major systemic breakdowns are, by nature, hard to predict, but we don’t think there’s any imminent risk of another financial crash on that scale at present. We don’t believe we’re going to see substantially negative real rates for some time and don’t see a compelling case to add gold to portfolios.
Does Bitcoin have a heart of gold?
Gold and Bitcoin have both been called ‘zero-income belief system’ assets.
This means they don’t pay an income – unlike equities and bonds – and their price is driven largely by investor sentiment. Both have value only in so far as investors have faith that someone, somewhere, will pay a certain price for it.
While these similarities certainly make a compelling case for Bitcoin – or perhaps another cryptocurrency – as a store of value, there are some key differences that make us wary. Gold has the momentum of thousands of years behind it – the oldest gold coins date back to 600BCE, and the commodity continued as the basis for currencies until just after the Second World War. It is a real asset that doesn’t degrade. It also can’t be hacked or have its value manipulated, unlike electronic currencies.
Cryptocurrencies have also proven to be very volatile. Gold prices can move sharply, but you are never likely to see the triple-figure percentage shifts in a few days that we’ve experienced for Bitcoin. While this remains a characteristic of cryptocurrencies, the dominance of old fashioned gold in the safe haven space seems assured for the foreseeable future.