Why investors are flocking to gold again

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This article first appeared in Corporate, The Edge Malaysia Weekly, on June 20 - 26, 2016.

RISING risk aversion due to the growing possibility of Brexit, coupled with negative interest rates in various markets, has sent gold prices higher. Experts say the precious metal will continue to see support going forward.

Year to date, spot gold prices have risen 20.48% to US$1,278.43 per troy ounce and news that billionaire George Soros has been betting on gold in recent times has added to its lustre. 

According to news reports, Soros Fund Management has purchased US$264 million worth of shares in Barrick Gold, the world’s largest gold miner. The fund has also acquired 1.1 million options to buy SPDR Gold Trust ETF, which mirrors the price of gold. 

What is more interesting, however, is that the Soros fund sold about 37% of its stock portfolio in the first quarter of the year. It has also been reported that the fund owns 2.1 million put options on SPDR S&P 500 ETF, which many interpret as the billionaire’s pessimism about the equity markets and economic recovery. 

Exchange-traded funds (ETFs) have become an increasingly popular way for investors to gain exposure to gold. A Bloomberg Intelligence report highlights that since the launch of the first gold-backed ETF — Gold Bullion Securities — in 2003, the precious metal’s value as an equity has increased dramatically. 

“Some ETFs, such as Spider Gold Shares, have a market capitalisation that is as high as US$34 billion, bigger than that of the largest global gold mines. These funds are extremely liquid,” the Bloomberg report adds. 

According to Bloomberg Intelligence analyst Eily Ong, investors have flocked to gold because there has been no change in the monetary policies of the US Federal Reserve, the Bank of England and the Bank of Japan while the threat of Brexit looms large. 

“BI analysis shows that the two key elements that contributed to the metal’s stellar price momentum in 2004 to 2015 were gold ETF demand inflows — used as a proxy in times of global financial or geopolitical crisis — and the US dollar’s weakness,” explains Ong in her report. 

“The combined elements may suggest the 33% gold price decline from its US$1,921 an ounce peak is enticing investors seeking a safe haven. Gold ETF demand inflows to June 16 rose 29% from the end of 2015 as the metal surged 22% and the Bloomberg Dollar Spot Index fell 4%.”

Over the last five years, the price of gold, which hit US$1,921 per troy ounce at its peak in 2011, has been falling. However, is there any more steam in the recent rally?

Capital Economics commodities economist Simona Gambarini says while she expects the Fed to resume its rate tightening later this year, real interest rates would remain low, supporting higher gold prices. “We expect the gold price to reach US$1,350 per troy ounce by the end of the year.”

She adds that a vote for Brexit may see an immediate surge in the gold price to US$1,400 per troy ounce. 

A June 17 report by Nomura says concerns over Brexit have spiked in the past two weeks and greatly impacted global risk appetite. It adds that most recent polls have consistently shown that the “leave” camp is ahead of the “remain”. 

“In a ‘leave’ vote scenario, questions about the global economic momentum will increase. Additionally, the possibility that this could prompt other EU members to follow suit could raise questions about the sustainability of the bloc. Such outcomes could further dampen capital expenditure intentions and overall sentiment,” adds the research house. 

Nevertheless, Nomura’s economists have maintained a “remain” vote as their baseline expectation and believe there is only a 25% chance of Brexit. 

At press time, official campaigning ahead of the referendum on June 23 was halted due to a fatal attack on British member of parliament Jo Cox last week. 

Meanwhile, AIMS Asset Management Sdn Bhd managing director and investment manager David Crichton-Watt believes the excessive sovereign debt burden that the global economy is facing is a factor that could prop up gold prices. 

“The banks in Europe, having been forced to hold government debt that now has negative interest rates, are clearly in trouble — the share prices of Deutsche Bank and Credit Suisse have hit new lows. And the European Economic Community has promised that there will be no more ‘bailouts’ but instead ‘bail-ins’, where people will have their deposits converted to shares in the defaulting bank,” he says.

Crichton-Watt adds that negative interest rates and threats of bail-ins have caused investors to hide their savings in gold. He opines that every investor should hold some gold as assurance against the global economy going wrong. 

“If central banks totally lose control, then we might see hyper-inflation and a total loss of confidence in paper money. In this case, the price of gold can be any figure you like. Investors have certainly not missed the boat. Gold stocks, despite having risen 150% this year, are still only a third of the price they were at five years ago and some are still absurdly cheap,” he points out. 

When asked if he sees any downside risk to gold prices, Crichton-Watt says there will be more surprises on the upside for gold with each consolidation short and not very deep. He adds that investors waiting for a pullback in gold prices are likely to be disappointed and could end up paying more. 

Meanwhile, Gambarini says the opportunity cost of holding gold is lost now that official interest rates in the EU, Switzerland and Japan have turned negative. “The low interest rate environment could stimulate demand for gold by central banks and investors alike as they struggle to meet their long-term investment objectives with only government bonds,” she explains. 

As for gold-related stocks, Crichton-Watt cautions investors who are eager to jump onto the mining bandwagon. “There is breathtaking volatility nowadays, largely as a result of the fact that the gold mining ETFs are much larger than the underlying companies. Mining anything is a very risky business and gold mining very often goes wrong. So, it wouldn’t be wise for an amateur investor to choose gold mining stocks,” he says.