Sometimes, what doesn’t happen is as noteworthy as what does. This is true of gold. For the last 18 months its price in sterling terms has been range-bound, trading between £920 and £1,030 per ounce. This is revealing, as it shows the limits of the metal and its virtues for investors.
First, it’s limitation. Gold’s stability in the face of rising UK consumer prices reminds us that the metal is not a reliable hedge against inflation. Since 2011, for example, it has lost 5 per cent in sterling terms while UK consumer prices have risen 10 per cent. This is not a recent development; the gold price fell in the 1980s even though consumer prices rose a lot.
Gold does, however, protect us from two things. Its stability this year reminds us what these are.
There’s a good reason why gold hasn’t changed much. It’s because real interest rates haven’t. Ten-year index-linked gilt yields have begun 2018 at much the same level they began 2017.
There has for years been a strong negative correlation between gold and index-linked yields. Both moved sideways in the late 1980s and early 1990s; gold soared in the 2000s as index-linked yields fell; gold fell in 2013 as linkers’ yields rose but rose as linkers' yields fell in 2016; and both have moved sideways since.
There’s a simple reason for this correlation. When you hold gold you give up returns on financial assets. The higher real interest rates are, therefore, the less attractive is gold as an investment. As rates fall, therefore, gold’s price should rise. And as rates rise, so gold’s price should fall. Which is what we see.
Herein lies the case for gold. It gives us insurance against a further fall in real interest rates.
You might think there’s only a slim chance of such a fall given that rates are already negative. Maybe. But many of the things that would cause such a fall would be nasty for shares: increased risk aversion among investors; slower growth; or deeper fears of continued low trend growth. A small chance of unpleasant events might well be worth buying some insurance against.
Gold also offers us another form of insurance – against sterling falling. Sterling-based holders of gold did nicely when sterling slumped immediately after the EU referendum, for example. And that wasn’t untypical. Since January 2000 there’s been a strong negative correlation (of minus 0.42) between gold’s sterling price and the $/£ rate, so that a weaker pound means a higher gold price in sterling terms.
Again, you might think there’s little chance of sterling falling. I sympathise: I suspect sterling is underpriced.
But, again, many of the things that would cause sterling to fall would be unpleasant: heightened risk aversion among global investors causing them to dump risky assets such as sterling; a slowdown in the UK economy; or more adverse sentiment about our longer-term prospects. Such events would see domestic equities do badly, and cause some of us to suffer a worsening of job or business opportunities. It might well be worth having insurance against such nasty risks even if they are low probabilities.
Of course, there’s a danger here. Gold might well do badly if sterling and/or real interest rates rise – events that are quite likely if the world economy continues to grow nicely.
This, though, merely reminds us of a basic truth – that insurance loses us money in good times. Insofar as there is a case for gold having a (small) place in our portfolios, it’s because the good times won’t last.
