However, Sector Investment Managers chief executive Angelos Damaskos, is “optimistic for the rest of the year” for gold equities. “Investors have to focus on value shares companies with sustainable cashflow and operations because a lot of early stage companies rely on capital markets to raise financing and a lot of capital markets are shut at the moment so a lot of smaller companies may go out of business or into hibernation for a while as they run down their cash balances.”
Damaskos says while equities do carry market risk, mining shares are at such low valuations that it is difficult to see them dropping much more and they have a good risk/ reward ratio with strong re-rating potential.
“Mining shares could easily double in the next year but on the downside I can’t see them going further – how much lower can they go?” he says. “I think the sensible investor would diversify their holdings between gold bullion and mining shares depending on their risk appetite.”
Inflation drivers
Whether or not institutions will invest in gold seems to hinge on how they foresee the economic situation panning out. With central banks ramping up the printing presses with QE there is a concern they may be debasing their currencies to inflate away their debts. In turn, this will reduce the real purchasing power (RPP) of their currencies and could encourage investors to hold gold as a hedge against a declining dollar.
“For an investor who believes those systemic concerns will come back, the threat of the US dollar ending as the reserve currency and is nervous about inflation, it would be seen as a safe-haven investment and the price would rise as a result,” says Mercer director of macro currency and commodity research Simon Fox.
Iveagh, the privately-owned investment management firm that evolved out of the Guinness family office, accesses gold through ETFs. Chief investment officer Chris Wyllie says Iveagh sold out of gold in February, but believes the reasons people bought gold in the first place still hold true.
“The big borrowers of the world need inflation to inflate away their debt,” he says. “Our reason for going underweight gold was not trying to undermine those arguments because they are all valid, but it was more from the momentum and sentiment angle. When the price started to show some weakness we thought there were some big downside risks as people started to recognise QE might be rolled back on – and that has now happened. If we start to see momentum reassert itself, we might go back in and neutralise our position, which is 3% or 4%.”
Damaskos is yet to be convinced the US is showing signs of growth and with Europe still in recession and emerging economies slowing recently, there is an opportunity for gold.
“We think there is a strong chance we will have another banking crisis or sovereign debt crisis that requires the ECB to intervene and pump in more liquidity.”
If this happens, Damaskos says, investors would be enticed back into gold for its insurance-like attributes. “At some point we are going to hit an iceberg despite the central banks’ effort – that is when gold is going to shine,” he says.
Elsewhere, gold does not provide investors with a yield meaning it risks being eclipsed by other asset classes if there is a return to a more ‘normal’ financial system, namely a reduction of output gaps and unemployment, below trend GDP growth and gently rising interest rates with positive real interest rates. In this environment, gold does not do as well because of its lack of yield.
WGC’s Grubb says: “Gold is not going to solve your return issue in the portfolio as it does not have a yield. You really have to be convinced of its properties to allow you to take more risk in other asset classes.”
And it seems larger institutions, such as pension funds and insurance companies, are not investing in gold because they typically do not rotate in and out of asset classes on a tactical basis.
All that glitters…
In fact “very few” of Mercer’s clients have a strategic exposure to gold, according to Fox. “But it does appear within some of the multi- asset mandates where active managers are making a specific view from their own asset allocation perspective,” he adds.
One of the reasons for this is that the monetary value of gold is hard to pin down making fair value difficult to identify.
“It [gold] is only defensive based on the fact it is valued fairly at the time you invest and to what extent you believe the systemic risks will increase in the future,” says Fox. “If there is an excessive valuation it is not potentially holding a defensive quality for you.”
Industry experts can envisage scenarios where the price of gold will rise but also where it will fall – and therein lays the challenge for institutional investors. If fear about the financial system, inflation or the banking sector in Europe re-emerges investors might turn to gold and prices rise as a result. But if sentiment becomes positive to the extent economies continue to stabilise and tail risks are perceived to have mitigated because of the actions of central banks and governments, the price of gold could fall back once again.
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