The Russian invasion of Ukraine has had many consequences – first and foremost is its devastating humanitarian impact. While we cannot lose sight of how many millions of people are affected, as investors we are conscious that this is a time of great uncertainty.
During times of market turmoil, investors turn to gold given its perceived safe haven status. As Russian troops invaded Ukraine on 24 February, the yellow metal reached $1,974/oz, the highest it’s been since September 2020.
At the time of writing on 2 March it stands at $1,929/oz.
Before the current crisis, the gold price was hovering around the $1,800/oz mark, having not made significant headway since late 2020.
Selling pressure from large institutional investors, particularly in North America, has more than offset strong demand from jewellery makers, central banks (as a reserve asset) and from bar and coin demand (often a form of saving/investment). Gold tends to reflect changing macroeconomic conditions well, and the price falls of late 2020 and 2021 were largely due to anticipation of monetary/fiscal policy normalisation after the Covid-19 crisis.
Demand for gold was rising even before crisis
Gold prices had been resilient in January and early February, despite sharp increases in US real interest rates - which would usually weigh on them. This is partly due to the geopolitical stress of the Russia/Ukraine situation, and this may continue to underpin moves higher if the conflict worsens or sanctions don’t have the desired effect.
However, even before the situation escalated, we were already seeing signs that institutional demand for gold as a portfolio hedging instrument was turning positive.
We think this will continue through 2022 regardless of how the geopolitical situation evolves.
Why might investors start allocating to gold now?
Besides looking for a store of value in times of heightened market stress, we believe many investors see the coming rate hiking cycle as extremely risky given the abnormal macroeconomic backdrop.
Apart from being highly indebted, developed economies have become reliant on massive monetary and fiscal stimulus. The potential for negative feedback loops (a reaction that causes a decrease in function in response to a stimulus) into the real economy and financial markets as stimulus is removed and interest rates rise, is elevated.
In other words, it’s entirely possible that rate hikes and the removal of quantitative easing could have such a negative impact on economies, in which consumers are already suffering negative real income growth, that they are reversed before too long.
The potential for stagflationary outcomes is high (i.e., low growth and high/rising inflation) and the probability that we remain in a long period of financial repression with negative real interest rates is also high. This is a very positive macroeconomic backdrop for gold.
Other portfolio diversifiers look less appealing
The current uncertainties suggest that institutions are likely to continue to give more consideration to portfolio diversifiers such gold, as other choices look less appealing.
The cryptocurrency space, which may well have attracted capital away from gold in recent quarters, is also under increasing regulatory pressure.
Meanwhile, in stark contrast to 2013 (when gold was dumped largely in favour of equity allocations) starting equity valuations are very high.
More broadly, it is difficult to argue that traditional hedging instruments, such as government bonds, are as appealing as they’ve been in the past, not least because economies are highly indebted, yields are still close to historical lows, and inflation could well be structurally higher.
Gold to become “TINA”?
Overall, we continue to believe gold should perform well in 2022. While the conflict in Ukraine could underpin further moves higher, with few other options for diversifying portfolios, we believe that gold is well on its way to becoming the “TINA” (there is no alternative) safe haven asset in coming years.