It appears the global gold rally won’t be stopping anytime soon. The spot price for the metal is floating comfortably above US$1,400 — a far cry from May when it was languishing somewhere in the neighbourhood of US$1,270. Gold ETFs have also seen increased interest, with data from Bloomberg and BlackRock indicating a US$4.3-billion boost in global investors’ positions in gold ETFs from May 14th through June 20.
The fact that bullion is trading near a six-year high points to a clearly rising fever, and as a recent note from BlackRock points out, there’s strong historical evidence to support it.
“Historically, gold has been a diversifying complement to a traditional stock and bond portfolio throughout market cycles,” wrote Christopher Dhanraj, head of the iShares Investment Strategy team at BlackRock. Drawing from data provided by Thomson Reuters, Dhanraj said that monthly returns of gold have had low to negative correlations with those of other major asset classes over the decade ended May 30, 2019.
He added that gold has performed other asset classes represented by the S&P 500, the US Bloomberg Barclays Aggregate Bond Index, and the Bloomberg Barclays US Corporate High Yield Index in the deepest drawdowns of the past three recessions. While analysts including BlackRock still see a late-cycle dynamic persevering over the near- to mid-term, there’s still the possibility of a recession — the US economy recently broke a record for its longest-ever expansion — that supports the case for gold exposure.
And while there’s also little prospect for inflation at the moment, Dhanraj noted that gold also offers a potential inflation hedge. “It is important to note that the level of real interest rates – the interest rate after inflation – is a key driver of gold returns,” he said.
Still, he clarified, holding gold has its drawbacks. Aside from generating no cash flows, the commodity produces no earnings for investors; those who physically own gold also have to consider storage costs. All three of those risk factors, he said, have contributed to the asset’s underperformance compared to traditional stocks and bonds over the longer term.
“Additionally, as a commodity, the physical supply and demand of gold is crucial idiosyncratic driver of the commodity,” Dhanraj said. The demand side is vulnerable to forces exerted by central banks, investors, and consumer preferences for the commodity; citing data from the World Gold Council, he said that only 59% of demand for gold in 2018 was for commercial uses, 26% was for investment purposes, and 15% was from central banks. This year has seen money pouring into the gold market, including inflows into gold-backed ETFs since late May.
Gold also faces supply-side risks should any increases in mining production manifest. Other factors, such as lack of inflation and a strong risk-on rally, may also affect its attractiveness to investors in the short term.
“A small allocation to gold may be suitable for investors who are looking to real assets to diversify their portfolio,” Dhanraj said. “However, investors should balance the sizing of their position given the lack of yield and low current inflation expectations.”
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