Gold is a scarce, historically reliable inflation hedge that can provide comfort even in relatively small denominations in a client’s portfolio should rampant debt and prolonged periods of sunken interest rates catch up to central banks and ultimately the currencies they issue.
Investors have seen some hardship in recent weeks as stock markets have fallen dramatically wiping out years of gains built up during the longest bull market in history. Covid-19 it seems was the long-feared knife to burst the Equity balloon. Similar to the most recent comparable crash of 2008 we have seen a pressure on central banks and governments to prop up economies and typically they have done this through the bond market. We however now see this intervention also spilling into the Equity market as the United States’ Federal Reserve has announced its purchase of Corporate Debt – suggesting that open market operations via bonds alone is either not suitable or simply not enough. This leaves investors worried for the prospects of both the Equity and Bond markets and asking the question – with respect to protecting my portfolio - what is the alternative?
The question almost answers itself in the form of the Alternative asset classes – however with the Real Estate market suffering from the slow down in the economy due to Covid-19 as rent payments go down with households struggling to maintain mortgage payments and small business go out of business the eye of the investor trails naturally to a more independent asset class – Commodities.
Commodities as an alternative asset class are typically viewed cautiously by the normal investor with a perilous example in the recent crash in oil prices fuelled by demand reduction due to Covid-19 and the preceding price war which has caused OPEC+ (the group that controls the production of most of the world’s oil) to slash production by 10 million barrels a day. The resultant infighting within OPEC+ and the further destruction of oil prices highlights the jeopardy at play within the Commodity sector for investors.
Gold however plays a different role in a client’s portfolio – the historical linking to currencies via the Gold Standard places this asset into the box of inflation hedging and as the ultimately defensive commodity.
After the abolition of the Gold Standard Western economies saw high levels of inflation during the 1970s and 1980s – Gold soared above $2,200 an ounce.
We are not in a period of hyperinflation however the possibility of rampant currency devaluation is real. Interest rates are now lower than ever before. The Fed’s balance sheet swelling by $1.1trillion in 4 weeks - The price of Gold, generally quoted in dollar terms, is affected positively by the weakening of the dollar.
Closer to home, The Bank of England now owns a quarter of the UK Gov Bond market - £200bn of which was purchased using money created “at the stroke of a keyboard” (Financial Times, https://www.ft.com/content/e7fa6ac4-c2a0-4c6c-b1e1-17ab91316915) to combat the negative effects of Covid-19 on the economy. This is combined with a £60bn support package for companies, workers and households during a period where expected tax revenues are set to plunge. How does a government pay off this swelling debt with a stagnant economy?
A question for the policy makers and central banks perhaps but the real effect on investors is undeniable; a combination of a) taxes going up and b) the value of cash going down. Whilst financial advisers cannot generally assist with the first, we can provide guidance on how to mitigate latter. In normal conditions monetary policy of this kind would almost certainly result in a sharp increase in inflation. In an environment where economies have ground to a halt due to coronavirus lockdown, we could see stagflation as employers furlough and make redundant large portions of the workforce.
The demand for Gold is generally for the preservation, accumulation and exhibition of wealth. This, combined with its relatively unhindered supply chain, protects it from the pitfalls of other commodities such as Oil or even the more volatile white precious metals (Silver, Platinum and Palladium). Gold is a scarce, historically reliable inflation hedge that can provide comfort even in relatively small denominations in a client’s portfolio should rampant debt and prolonged periods of sunken interest rates catch up to central banks and ultimately the currencies they issue.
Euan Spencer
Trainee Financial Adviser
SaSo Strategic Advisers
27th April 2020
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