Is your portfolio insured?
Author: Ani Markova
August 16, 2017
Precious Metals Insights from the desk of Ani Markova
As many investors know, the summer months are a seasonally weak period for the precious metals space and this year is no exception. Since January of this year, the gold price has been range bound between $1,200-$1,300, with a correction of 6% in June and July. The gold stocks represented by the S&P/TSX Global Gold Index are also down 15% during this same June-July period, drifting in a sideways pattern.
CFTC short positions are also approaching five-year highs, indicating a lack of investor conviction in the asset class. Historically, when short positions start to unwind, gold has rallied meaningfully. It is our belief that in such periods of weakness it is important to take advantage of undervalued asset classes that can serve as portfolio insurance.
Source: Bloomberg, as of July 27, 2017
The constant turmoil and controversy at the White House and the inability of the Trump administration to attract political leadership and collaboration diminishes investors’ confidence of major fiscal policies being put forward at a time when central banks are starting to unwind stimulus and the global economy is showing signs of slowdown. Recently, the IMF revised its U.S. growth rates down to 2.1% for 2017 (down 0.2%) and 2.1% for 2018 (down 0.4%), citing diminished fiscal policy expectations¹. In general, equity markets could potentially be faced with some level of volatility should recent momentum fade.
As the gold sector has effectively no correlation to the general equity market, investing in uncorrelated assets should bring better portfolio diversification. During such volatile times, it is our belief that gold and precious metals related equities will be viewed as a safe-haven investment alternative.
Source: Bloomberg, for the 10-year period ending July 27, 2017
Considering an allocation to gold
Historically, between 1-5% of investable assets have been allocated to gold. In an effort to illustrate gold’s risk reduction properties, the World Gold Council has suggested that a portfolio with an allocation of 5-6% to bullion outperformed a general portfolio by 735 basis points during tail-risk events, such as Black Monday, the DotCom bubble, the terrorist attacks on September 11, 2001, the sovereign debt crisis, and others².
In a more recent study published by the CPI Group, a portfolio with 27-30% of its assets in gold had the best risk/reward characteristics over longer periods of time³.
Source: CPI Group, as of December 2016
As this asset class is quite volatile, investors should consider allocating an appropriate proportion to gold investments according to their investment horizons. However, having some exposure to this asset class offers numerous benefits, in our view, as demand for the metal is expected to be driven mostly by its use as a safe haven asset, currency hedge and an alternative asset, with inflation hedge and wealth preservation characteristics.
During its history, gold prices tend to be influenced by various factors. In the recent past, however, the bullion has been influenced by real rates (nominal interest rates minus some form of inflation). The biggest threat to the gold trade is rising long-term real rates, which is possible on the back of unwinding of Fed and ECB balance sheets. The economic risk, however, is that rising cost of capital stalls the already fragile economic expansion, causing slowdowns or recessions.
Without strong signs of inflation as we are witnessing today, we believe it is likely that the Fed could alter their tightening cycle if economic softness persists. If such action were to transpire, the gold price should react positively as the USD softens. Also to consider is that in 2018, the Fed will have new leadership and it is uncertain which direction the central bank will take.
Trade wars are another risk to the economic landscape. As we witness the lack of results from high-level economic talks between China and the U.S., there is a material risk that the Trump administration will feel pressure to switch to confrontation, rather than cooperation to solve the US$347 billion trade deficit with China – raising geopolitical tensions around the world even further.
In our view, the summer doldrums is a good time for investors to purchase portfolio insurance at discount prices. We expect investors’ interest to return to the precious metals space in the fall as we get closer to U.S. debt ceiling negotiations and we gain a clearer picture of the Trump budget proposal. If the U.S. GDP is unable to grow above 3% over the next 10 years, budget deficits will add to the overall U.S. debt, which currently stands at US$19 trillion4, eroding the value of the USD and the confidence of it being a reserve currency. In such an environment, gold is likely to shine again.
¹Source: IMF World Economic Outlook Update, July 2017
²Source: World Gold Council – Gold Investor, Risk Management & Capital Preservation, March 2014
³ Source: CPM Group, “Gold Yearbook 2017”, March 2017
4U.S. Treasury Total Public Debt Outstanding. Source: Bloomberg, as of July 27, 2017
Commentary and data are sourced from Bloomberg and Reuters except where referenced. The commentaries contained herein are provided as a general source of information based on information available as of July 27, 2017 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. The information contained in this commentary is designed to provide you with general information related to investment alternatives and strategies and is not intended to be comprehensive investment advice applicable to the circumstances of the individual. We strongly recommend you consult with a financial advisor prior to making any investment decisions. This document is intended for advisors to support the assessment of investment suitability for investors. Investors are expected to consult their advisor to determine suitability for their investment objectives and portfolio.