Outlook 2018: Gold

We see the gold market as broadly overlooked and offering great value as a portfolio hedge at current levels.

12-13-2017
Hedge-over-clear-sky

Authors

James Luke
Fund Manager, Metals
Mark Lacey
Head of Thematic Equities

2017 has been a great year for risk assets. However, elevated valuations in multiple asset classes and growing political uncertainty mean that as we enter 2018 the case for finding alternatives to diversify away from these asset classes is stronger than for many years.

For investors looking to hedge their portfolios, the outlook for gold (and silver) prices appears very strong, with several key drivers converging:

  1. The need for global real interest rates to remain negative amid record debt levels
  2. Global geopolitical uncertainty is high and increasing
  3. There is increasing evidence that inflation has bottomed
  4. The dollar is potentially entering a bear market
  5. Gold remains under-owned
  6. Broad equity valuations are extremely high

We believe that the first three points are self-explanatory, so we shall focus on the last three.

A potential US dollar bear market

For context, the dollar bull markets of the early 1980s and the late 1990s each lasted around six years on average. The most recent bull market which commenced in 2011, has also lasted just over six years (chart 1).

Gold-outlook-chart-1

Past performance is not a guide to future performance and may not be repeated.

Several factors we believe make dollar weakness a high probability outcome over the next few years, of which three stand out:

  1. A likely increase in the US twin deficit;
  2. Potential increased political dysfunction in the US;
  3. The fact that the US is more deeply indebted than commonly perceived.

US central government debt is close to 10x total central government income (taxation) .

Gold is under-owned

Although there has been pick-up in both gold and gold equity prices in 2017, gold as an asset class remains under-owned. The positive investment cycle in this asset class potentially has many years to run. Current gold ETF (exchange-traded fund) holdings as a percentage of global ETF assets are tiny. As chart 2 below shows, in 2012 gold was relatively well-owned, with gold ETFs over 10% of all ETF assets (including equities, bonds etc.).

Since then ETFs have expanded across asset classes while we have seen strong bull markets in bonds and equities. At the same time, and partly as a result, gold ETF holdings have fallen from over 85mn ounces in 2012 to around 68mn ounces (in August). Gold ETFs as a percentage of all ETF assets are now closer to 2%.

For gold, in a world still awash in liquidity and with financial asset values very high, this is positive. So when investors start meaningfully allocating to gold again, gold ETF holdings have the potential to grow at a pace significantly higher than the 2004 to 2012 period.

Gold-outlook-chart-2

Gold does well when equities do badly

Equity valuations are now extremely high, with global equity markets having added close to US$9.5tn in market capitalisation over the course of 2018. Historical data going back to the 1970s shows that over reasonable periods (five years plus) when returns from equities have been poor, returns from gold have been strong.

Gold has been a very good portfolio hedge against equity bear markets and periods of high inflation. Should global equity euphoria weaken in 2018, gold stands to benefit significantly and thus firmly supports the argument for holding a minimum weighting in gold or gold equities in a portfolio.

Gold equities remain very out of favour

If we look at gold equities, we see a similar picture. The current weighting of North American gold equities in the S&P500 and TSX has fallen to just 0.6% after reaching a peak of over 2% in 2012. In fact all North American (US and Canadian) gold producers have a combined market cap of less than $150bn. This highlights the scarcity value of gold equities if a bull market in gold gets going.

The fact that the majority of the companies we invest in have improving fundamentals and are trading at the lower end of their historical valuation range adds further weight to the attraction of this sector in 2018.

Gold-outlook-chart-3

In summary, given many asset classes have appreciated so much over the last few years, we see the gold market as broadly overlooked and offering great value as a portfolio hedge at current levels. 

The full series of Outlook 2018 articles can be found here.

Subscribe to our Insights

Visit our preference center, where you can choose which Schroders Insights you would like to receive

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.

Authors

James Luke
Fund Manager, Metals
Mark Lacey
Head of Thematic Equities

Topics

Follow us

Please consider a fund's investment objectives, risks, charges and expenses carefully before investing.

The website and the content included is intended for US-based financial intermediaries (and their non-US affiliates) on behalf of those of their clients who are both (a) not “US persons” as that term is defined in Rule 902 under the United States Securities Act of 1933, as amended (the “1933 Act”) and (b) “non-United States persons” as that terms is defined in Rule 4.7(a)(vi) under the Commodity Exchange Act of 1936, as amended. None of the funds described herein is registered as an “investment company” as that term is defined in the United States Investment Company Act of 1940, as amended, and shares of the funds described herein have not been and will not be registered under the 1933 Act or the securities laws of any of the states of the United States. The shares may not be offered, sold or delivered directly or indirectly in the United States or for the account or benefit of any “US person.”

The information contained in this website does not constitute an offer to purchase or sell, advertise, recommend, distribute or solicit a subscription for interests in investment products in any Latin American jurisdiction where such would be unauthorized. The information contained in this website is not intended for distribution to the public in general and must not be reproduced or distributed, entirely or partially to any individuals who are not allowed to receive it according to applicable legislation. The investment products and their distribution may not be registered in Latin America, and therefore may not meet certain requirements and procedures usually observed in public offerings of securities registered in the region, with which investors in the Latin America capital markets may be familiar. For this reason, the access of the investors to certain information regarding the investment products may be restricted. Financial intermediaries and Advisors must ensure the information provided in this website is appropriate and suitable to the receiver’s domicile and jurisdiction and according to the applicable legislation.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security/sector/country.

Issued by Schroder Investment Management (Europe) S.A., 5 (“SIM Europe”), rue Höhenhof, L-1736 Senningerberg, Luxembourg. Registered No. B 37.799

Schroder Investment Management North America Inc. (“SIMNA”) is an SEC registered investment adviser, CRD Number 105820, providing asset management products and services to clients in the US and registered as a Portfolio Manager with the securities regulatory authorities in Canada.  Schroder Fund Advisors LLC (“SFA”) is a wholly-owned subsidiary of SIMNA Inc. and is registered as a limited purpose broker-dealer with FINRA and as an Exempt Market Dealer with the securities regulatory authorities in Canada.  SFA markets certain investment vehicles for which other Schroders entities are investment advisers.

Schroders Capital is the private markets investment division of Schroders plc.  Schroders Capital Management (US) Inc. (“Schroders Capital US”) is registered as an investment adviser with the US Securities and Exchange Commission (SEC).  It provides asset management products and services to clients in the United States and Canada.  For more information, visit www.schroderscapital.com

SIM (Europe), SIMNA, SFA and Schroders Capital are wholly owned subsidiaries of Schroders plc.