Falling yields – has gold got its shine back?

Gold has been trending upwards since the fourth quarter sell-off and is now at its highest level since 2013. In this month’s video, Investment Director, Ritu Vohora looks at the driving forces behind investors’ renewed interest in the yellow metal.

 

August saw the return of risk aversion, as President Trump escalated the trade war with China, and the US labelled China a “currency manipulator”. As global growth concerns rippled through the global economy, equity markets tumbled and safe havens rallied.

Gold was the top performing asset class in August, and is now at its highest level in six years. With investors positioning for the worst, global government bonds rallied pushing yields to historical lows. This boosted the pile of negative yielding debt to over $16 trillion – with almost 30% of investment grade bonds now at negative rates. Importantly, the 10-year US Treasury yield fell below the 2-year yield for the first time in more than a decade. The yield curve inversion sparked recession fears, as it has historically been a useful indicator.

As trade concerns intensified, global equities sold-off in the month, with the MSCI All Countries World Index falling over 2%, in US dollar terms. Japan and the US fell the least, while emerging markets fared the worst. Chinese and Hong Kong markets underperformed the most, with headwinds from protests and ongoing trade woes. Defensive bond proxy sectors such as utilities rallied, while the flattening yield curve proved a headwind for financials. Cyclical sectors, energy and materials, were also hurt by trade concerns and weaker macro data.

Sterling came under heavier pressure after Boris Johnson’s government signalled its intention to suspend parliament in a bid to stop MPs blocking a no-deal Brexit. The FTSE100, usually helped by a weaker sterling, underperformed its more domestic counterpart, due to its higher commodity and financials exposure.

Since the market wobble at the back end of 2018, the price of gold has been trending upwards. It’s currently sitting above $1500 per troy ounce, its highest level since 2013, and is up 18.5% year-to-date. The low rate environment, slowing global growth and continuing trade and geopolitical tensions, have been the driving forces behind investors’ renewed interest in the yellow metal. We’ve seen a rise in demand for both physical gold and gold-backed ETFs.

The growing interest in physical gold is, in part, a result of diplomatic and trade spats – with central banks topping up their gold reserves and emerging market countries in particular looking to diversify their reserve assets. Year-to-date, central banks in Poland, Russia, China, Turkey and India have been boosting their gold reserves.

Meanwhile, investors have been piling into gold-backed ETFs, to hedge against the possibility of a US slowdown, and as an antidote to plummeting bond yields. Gold-backed ETFs provide a more efficient and cost effective way for investors to gain exposure.

Following the Fed’s dramatic pivot, where markets have gone from expectations of successive US rate rises into anticipating several rounds of rate cuts in 2019 – investors have grown increasingly concerned about a slowdown in the US economy. At the same time, demand for gold has been on the rise as bond yields fall and investors question the longevity of the equity bull market.

Holding bonds has traditionally provided a hedge against equity market volatility. However, with bonds falling into negative-yielding territory, investors are now having to pay up for this ‘perceived’ safety. The amount of negative yielding debt has more than doubled since October last year, rising from $6.4 trillion to over $16.8 trillion (Bloomberg Barclays Global Aggregate Negative Yielding Debt Index) currently and the rise in the gold price has closely tracked this trajectory.

As yields continue to plummet, many investors are seeking to diversify elsewhere and are seeing more protection in gold. Ordinarily, in holding a zero-yielding asset like gold, investors would be forgoing the interest paid on bonds, but this opportunity cost is fast disappearing, as central banks drive down policy rates in an effort to shore up their economies.

With government bond yields following suit and credit spreads narrowing, these traditional safe havens are no longer providing the protection some investors are looking for. US 10-year Treasuries are still offering positive yields, but the direction of travel has changed.

Gold tends to perform well in times of uncertainty and heightened risk aversion. Ongoing trade wars and slowing economic growth, combined with persistently low yields, is increasing the attractiveness of gold as a safe haven and store of value. Furthermore, should ‘trade wars’ turn into ‘currency wars’, unlike fiat currencies, gold will retain its purchasing power.

A strong US dollar can be a headwind for gold, but the Fed’s more dovish stance, the diversification of reserve assets by emerging market central banks and President Trump’s own attempts to weaken the US dollar, could take the steam out of the greenback’s upward trend.

We are likely to see a continuation of the risk factors that have boosted interest in gold year-to-date. Global economic uncertainty is feeding into equity market volatility and evaporating bond yields, making it increasingly challenging for investors looking to diversify risk. Like any market, sentiment plays a big role in the price and demand for gold. In the search for safety – at least for now – gold seems to have regained its lustre.


The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.