Is it Gold's Time to Shine?

Gold remains relatively inexpensive in the face of record-high equity prices and spiking bond yields.
Reported by Debbie Carlson
In an era of economic and political uncertainty, interest in holding gold may be returning.
The continued extraordinary monetary policy by the European Central Bank and Bank of Japan means questions about global growth still linger, and new concerns about changes in political leadership in the US, UK and Europe are making gold attractive again.

The precious metal is considered a safe-haven asset, one of the few markets along with US Treasuries and cash that investors turn to when they become risk adverse. It’s also an asset that remains relatively inexpensive in the face of record-high equity prices and spiking bond yields, another plus for the yellow metal.

Gold is well off the all-time nominal high price set in September 2011 of just over $1,900 an ounce. The rally was fueled by worries over expanding central-bank balance sheets, culminating with a stand-off between President Barack Obama and Congressional Republicans about lifting the US debt ceiling. As of early March, gold traded around $1,230 an ounce, a good $130 off the low set in December 2015, when the Federal Reserve raised interest rates for the first time in several years.

Matthew Michael, emerging market debt and commodities product director at Schroders, said it’s seeing renewed interest in buying gold.
“We have started to see a return of good performances, so naturally people are asking questions about how do we access the market, what’s the sensible way to do it,” he said.
Yet some asset owners remain hesitant to buy gold, whether it’s concerns about market illiquidity or that the metal itself produces no dividends. But even a small holding of gold can offer diversification benefits, industry watchers say.

Diversified 60/40 Portfolio with and without Exposure to Gold

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Gold’s Role In Portfolios
Gold can perform a few different roles in a portfolio, usually as a diversifier or a hedge, said Adrian Day, president of Adrian Day Asset Management, who has advised asset owners on using gold.
“It’s very important when people buy gold or gold assets that they have a very clear idea in their mind why they’re buying it and what the purpose is. It helps determine what form to hold it in, and also it helps determine when they should sell,” he said.

Most investors understand gold’s role as an insurance policy to protect portfolios against extreme events. For instance, in 2008, all markets fell, including gold. However, by 2008’s end, gold prices rose about 5%, making it one of the few markets to end the year positively.
In the current market environment, gold isn’t tightly correlated with stocks or bonds, Day said. Even if an asset owner thinks President Donald Trump will simply cut taxes and regulations to help businesses, and the Federal Reserve won’t raise interest rates much, stocks and bonds remain expensive.

“In that long-term view, one would have to think there’s a high probably the bond cycle has peaked. Whether you think interest rates will zoom up is another matter. It’s a good possibility we’ve seen the highs in bonds, and stocks are expensive. I would say this is from that portfolio diversification point-of-view, I can’t think of a better time than now to buy gold and add some diversification,” Day said.

Ways to Buy Gold
There are several different ways to buy gold. The most popular method for asset owners is via exchanged-traded funds, but there are also futures and options on futures contracts, options on ETFs, other structured products, and owning physical gold itself. Gold-mining stocks, while not a direct way to own gold, can also fall into this category.

With many more vehicles available to trade, gold has caused the market to become much more robust. Trey Reik, senior portfolio manager and precious metals strategist at Sprott Asset Management, said asset owners shouldn’t be concerned about market liquidity when trying to get into and out of positions.

“’When liquidity and stress are on the rise, there are a lot of market players who sell their gold. The daily liquidity of the gold market is enormous, in both futures and over-the-counter. Liquidity is not an issue for investors,” Reik said.

Annual Performance of Spot Gold

USD Euro Yuan Rupee Yen Pound CAD AUD CHF Average
2001 2.50% 8.10% 2.50% 5.90% 17.60% 5.30% 8.70% 11.80% 5.30% 7.50%
2002 24.80% 5.80% 24.80% 24.10% 12.60% 12.70% 23.50% 13.90% 3.90% 16.20%
2003 19.40% -0.20% 19.40% 13.50% 8.00% 7.80% -1.80% -11.20% 7.30% 6.90%
2004 5.50% -2.20% 5.50% 0.50% 0.70% -1.80% -2.20% 1.40% -3.10% 0.50%
2005 17.90% 35.10% 15.00% 22.20% 35.70% 31.40% 14.10% 25.80% 36.00% 25.90%
2006 23.20% 10.50% 19.10% 21.00% 24.30% 8.20% 23.50% 14.60% 14.20% 17.60%
2007 31.00% 18.50% 22.50% 16.60% 23.00% 29.30% 11.40% 17.80% 22.00% 21.30%
2008 5.80% 10.60% -1.10% 30.60% -14.10% 43.90% 29.90% 31.60% -4.90% 14.70%
2009 24.40% 21.10% 24.40% 18.90% 27.40% 12.20% 7.90% -2.40% 20.40% 17.10%
2010 29.50% 38.90% 25.00% 24.40% 12.90% 34.10% 22.00% 13.70% 16.90% 24.10%
2011 10.10% 13.50% 5.20% 30.70% 4.40% 10.60% 12.50% 9.80% 10.60% 11.90%
2012 7.10% 5.20% 6.00% 10.50% 20.50% 2.30% 4.90% 5.80% 4.40% 7.40%
2013 -28.00% -31.10% -30.10% -18.80% -12.50% -29.40% -23.10% -16.30% -30.10% -24.40%
2014 -1.70% 12.00% 0.80% 0.50% 11.90% 4.50% 7.40% 7.40% 9.90% 5.90%
2015 -10.00% -0.20% -6.40% -6.20% -10.10% -5.30% 6.60% 0.30% -9.90% -4.60%
2016 8.60% 11.80% 16.10% 11.40% 5.30% 29.60% 5.60% 9.70% 10.50% 12.10%
10-YR RTRN 81.00% 126.00% 61.00% 178.00% 77.00% 187.00% 109.00% 98.00% 51.00% 109.00%
Gold ETFs can be backed by physical gold, like the two largest by assets under management, the SPDR Gold Trust (GLD), which has nearly $34 billion in assets under management, and iShares Gold Trust (IAU), which has $8.6 billion, as of early March. Gold ETFs can also be backed by futures contracts or other exposures. There are more than two dozen gold ETFs available globally.

Securities and Exchange Commission 13F filings show big institutional ownership of GLD and IAU. As of Dec. 31, 2016, institutions comprised about 40% of GLD total holdings. Similarly, institutional holdings for IAU are about 45% of total holdings.

Shayne McGuire, portfolio manager for emerging markets and the Gold Fund for Teacher Retirement System of Texas, said he understands that asset owners might have difficulty using gold in portfolios since it doesn’t allow for traditional cash-flow valuations, leading to misconceptions about the asset.

Popular Gold Miners-Equity ETFs

1-yr 5-yr
GDX VanEck Vectors Gold Miners ETF 6.93% -15.78%
GDXJ VanEck Vectors Junior Gold Miners ETF 30.37% -18.45%
SGDM Sprott Gold Miners ETF 2.43% n/a
RING iShares MSCI Global Gold Miners ETF 4.56% 16.77%
SGDJ Sprott Junior Gold Miners ETF 22.58% n/a
GOEX Global X Gold Explorers ETF 41.96% -15.13%
PSAU PowerShares Global Gold & Precious Metals Portfolio 9.63% -14.39%
“Perhaps the most important one is that gold is often regarded as an Armageddon asset class, something to hold only in very bad times. Historically speaking, this makes no sense as for millennia it has been a currency, a traditional way to store wealth. I think gold—like stocks, bonds, real estate and other assets—has investment merits and demerits and that it should not be completely avoided simply because it does not fit neatly into traditional buckets,” he said.
TRS has invested in gold indirectly via mining stocks for many years, but the TRS Gold Fund, which is a dedicated strategy, was launched in October 2009, McGuire added.

He said TRS’s Gold Fund uses ETFs exclusively and uses gold as a portfolio diversifier. Their last filing showed they held about $33.5 million in gold—although that is in addition to silver and precious-metals equities—out of a $130 billion portfolio, as of Dec. 31.

Popular US Gold-Backed ETFs

1-yr 5-yr
GLD SPDR Gold Shares ETF -5.58% -7.17%
IAU iShares Gold Trust ETF -5.54% -7.02%
SGOL ETFS Physical Swiss Gold Shares ETF -5.62% -7.16%
OUNZ Van Eck Merk Gold Trust ETF -5.63% n/a
DGL PowerShares DB Gold Fund DB Gold Inx Fund -6.93% -8.26%
GLDI Credit Suisse X-Links Gold Shares Covered Call ETN -3.65% n/a
UBG ETRACS UBS Bloomberg CMCI Gold Total Return ETN -2.62% 6.85%
Their gold allocation committee meets monthly to determine the proper allocation for the trust. The committee takes into account factors that historically have significantly impacted the metal’s price, such as the level of US real interest rates, the US dollar, changes in central bank holdings and demand from Asia—which represents about half of total global physical demand for gold—among other factors.

TRS measures the Gold Fund versus a custom benchmark of 35% gold, 15% silver and 50% precious metals equities, based off the Philadelphia Stock Exchange Gold & Silver Index, which has the longest history.

“Given that we can gain alpha by playing the metals versus stocks and via stock selection, this has provided us with less volatility [in comparison with traditional gold equities-only funds] and yet more potential upside than gold alone can provide,” McGuire said.

Gold and commodities in general often hold a small percentage of any portfolio. General consensus suggests a 5% holding for commodities overall. McGuire said TRS’s precious-metals holdings have ranged between approximately $100 million and $900 million, but that the Gold Fund has remained below 1% of total TRS assets.

A spokesman for the State of New Jersey Common Pension Fund D, which is one of the largest holders of GLD and IAU according to 13F filings, said the fund’s combined gold ETF holdings represent 0.21% of $71 billion it has in total fund assets. The gold ETFs are held as part of the fund’s Risk Mitigation portfolio, said Willem O. Rijksen, director of communications, office of the state treasurer, New Jersey Department of the Treasury.

Gold-Backed ETFs, Non-US

1-yr 5-yr
ZGLD ZKB Gold ETF—Switzerland -0.33 -4.6
PHAU ETFS Physical Gold—UK -1.96 -6.06
4GLD Xetra Gold EUR—Europe 3.58 -1.54
GBS GBS Bullion Securities—UK -1.93 -6.08
SGLD Source Physical Gold ETC (P-ETC)—UK -1.73 -5.95
SGLN iShares Physical Gold ETC—UK -1.77 -5.93
XAD1 db Physical Gold Euro Hedged ETC—Europe -3.92 -7.22
JBGOUA JB Physical Gold Fund USD A—Switzerland 14.94 -1.28
Joe Cavatoni, managing director, USA and ETFs, for the World Gold Council, the market-development organization for the gold industry, works with institutions about using gold in their portfolios. He agreed that although gold is often thought of as insurance, it works in all market conditions. Despite some investors concerns about an expressed lack of a dividend, Cavatoni explained how gold offers a return.

Using a traditional basic portfolio of 40% bonds and 60% equities, where 35% is the Barclays aggregate bond index, 5% is in short-term Treasuries and equities are globally diversified, over a 10-year period that portfolio would return 5.1% with volatility at 10%. With a 5% allocation to gold over the same period, the portfolio returns 5.3% and volatility falls to 9.5%.
“For the last 10 years, it was not such a bad decision to be in [gold],” he said.

For asset owners interested in either owning gold-backed ETFs or physical gold itself, there are a few technical cost factors that differ from traditional stocks or bonds, Cavatoni and Day said.
Owning physical gold includes vaulting fees and insurance to ensure the asset is safeguarded. That’s the case whether it’s the ETF that does the supply management, or an asset owner who works with a custodian to hold their metal. Costs vary on the amount of gold owned, but ETFs can offer a lower cost of ownership and an easier mechanism to trade gold close to the spot price.

For asset owners who are not running tax-exempt funds, unlike stocks, gold’s capital gains are taxed at a collectible rate, which can be as high as 28% when the asset is sold, whether it’s a gold-backed ETF or physical metal.

Market Outlook
Geopolitical concerns are supporting some of gold’s strength. Coming elections in France, the Netherlands and Italy, where anti-European Union and anti-euro currency politicians have had their strongest showing in years, are unnerving some, said Mike Ciccarelli, commodities analyst at Briefing.com, as has the UK Brexit vote and Trump’s election in the US.

Other factors are also underpinning the yellow metal, said Ciccarelli and Schroders’s Michael.
Inflation is starting to rise, after being benign for several years, seen by gains in most commodity prices last year as supply and demand is changing, Michael said.

“Whether it’s an increase in commercial lending, an increase in fiscal stimulus or indeed down to the fact there’s a huge amount of liquidity in global financial system broadly, if prices move up, people change their intentions and they make their purchases sooner as they start to worry about rising prices. We’re moving to that point of a cycle where things become more expensive and investors begin to take note. That in itself will be a power driver of gold prices,” Michael said.

Ciccarelli said he’s not concerned about gold’s performance if the Fed continues to raise interest rates because he doesn’t see a sharp rate hike. He said gold rebounded after initial breaks following the last two raises in interest rates, in December 2015 and December 2016.
Michael said Schroders’ research shows commodities perform better through Fed hiking cycles than cutting cycles. The average return in commodities through a Fed hiking cycle is plus-17%, while during a cutting cycle the return is minus-2%.

“Specifically related to gold, in the last four instances where the Fed had embarked on a hiking cycle from beginning to end, in three of the four instances, gold saw 20% returns,” Michael said.
Rising interest rates might mean a stronger dollar, and that could be a headwind for gold and other investments in general in the shorter term, Ciccarelli and Michael said. There are a few ways of looking how gold might perform in a strong-dollar environment.

Normally, gold prices fall when the greenback rises because gold is dollar-denominated. However, because gold is sometimes considered an alternate currency, it can be used as a hedge. Michael and Sprott’s Reik noted the drop in non-US currencies has made gold’s performance as valued in euros, pesos, yen, and other currencies look strong.

For investors not quite ready to have a direct gold investment, gold equities can be a proxy.
Michael said dollar strength may make some gold equities look even more appealing than direct gold investments.

“A lot of miners are based in countries like Australia, Canada, and South Africa. The collapse in their currencies means they’re selling a product based in dollars and repatriating the profits from that in local currencies, making the companies look very attractive from all measures,” he said.
Miners have also become more disciplined than in the past, with better management focusing on free cash flow and controlling costs.

“Because of the concentrated revenue streams, they’re far more correlated to the direction of gold and silver prices than the S&P … for example. If you run a simple chart of the S&P 500 or whatever, relative to the gold-mining index, the dispersion in performance is close to 70%. As long as the sector is functioning and relevant to what is happen in gold, these stocks should be considered part of a commodities allocation,” he said.
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