While global markets are generally expected to grow in 2017, it is also expected to be somewhat of a volatile year. The world is eagerly watching to see how ’Trumponomics’ will unfold and its implications for the US and global economies. Equally significant is the exit of Britain leaving the EU, but the real impacts may not be known for some time. Further political risks loom in 2017 with the Netherlands, France and Germany all going to the polls for key elections.
During times of uncertainty, gold is always in the spotlight. It is worth noting that gold is both an investable asset, as well as a consumable one, both having implications on the underlying price.
A top performing asset class
After having reached a peak in 2011, the gold price has come off quite sharply until the end of 2015. In 2016, however, it proved to be one of the best performing asset classes, having risen 10% in USD terms, albeit with much volatility (as seen below).
What is quite interesting in the above graph, is that when Trump won the election on 8 November 16, most investors largely expected the gold price to soar as investors sought to offload risk.
However, the price decreased sharply, as the ’Trump effect’ was outweighed by the announcement of the Indian Prime Minster, Narendra Modi, that 500 and 1000 rupee notes were to be banned. These large notes were often used in the black market economy to buy gold, thereby ’legitimizing’ the funds. If one considers that the black market economy is about 25% of the total economy and that the large notes represent 20% of the cash in circulation, preventing these funds from buying gold has a significant impact on the demand and price of gold.
This highlights the impact that the Asian markets (particularly India and China) can have on the gold price.
Rising gold demand, particularly in Asia
In Asian markets, gold demand is closely correlated with increasing wealth. With a strong economic outlook, demand for gold is set to continue. In India, research shows that a 1% increase in income per capita relates to a 1% increase in gold. With a 2016 GDP growth rate of 7.6% and 6.7% and given the population size, India and China are set to lend further support to the gold price through increased demand.
Rising inflation is making gold a more attractive investment
More recognized drivers of the gold price are interest rate and inflation expectations. Stateside, President Trump spoke of fiscal spending and ambitious plans to kickstart an infrastructure boom. Combined with proposed tax cuts, this has several implications for interest rates and inflation.
Keep in mind that real interest rates are the key driver of the demand and price of gold. Real interest rate is the nominal interest rate less inflation. Nominal rates in the US are largely expected to increase this year. Fiscal spending will likely lead to more US Government borrowing, hence driving up bond yields and thus, interest rates.
Arguably however, inflation is set to increase at a greater rate, thereby reducing the real rate of interest. Fiscal spending and tax cuts will both add to inflationary pressures. The US job market is tight, with unemployment at less than 5%, which could result in higher wages and further fuel inflation.
The upward inflationary trend makes gold more attractive for three different reasons. Firstly, gold is largely seen as an inflationary hedge. Secondly, because real interest rates are low, the opportunity cost of holding gold is lower. In other words, you’re not losing out on higher interest rates earned in money market accounts because you’re invested in gold, which is a non-income yielding asset. Thirdly, inflation makes bonds and fixed income products less attractive.
Is gold the best option for investment?
If you are expecting steady global growth and strong corporate earnings with few economic and political surprises, then equities may potentially be a better investment.
However, if you view gold as a hedge to political uncertainty and economic volatility, and considering the potential price appreciation due to factors mentioned above, then it is an asset class that you would want to be invested in.
How to invest in gold
The average investor has various options to gain exposure to the precious metal. The most direct exposure is through buying the actual commodity itself, through bullion (gold bars) or gold coins like Kruger Rand. An investor must just keep in mind that there are hidden costs involved in holding physical gold in the form of secured transport, transaction costs, insurance and holding costs. These costs, especially insurance, can add up and carve away gains made from the growth of the investment. Safety is also an issue for physically holding gold.
ETFs (Exchange Traded Funds) that track the gold price are a viable option to gain gold exposure, with significantly lower transaction costs. New Gold Issuer Ltd (JSE ticker: GLD) is an ETF that trades on the JSE. Worth noting is that this ETF is physically backed by gold, unlike many ETFs in the US. As it is a JSE-listed instrument, it offers full protection, which differs to ETNs (Exchange Traded Notes). Investors should note that this ETF cannot be invested through the tax-free savings account, as is the usual case with ETFs.
Highly geared derivatives for gold is an option for experienced investors and traders in the futures market, but is not recommended for everyone. Gold is a highly volatile commodity and the leveraged nature of futures can lead to big losses, as well as profits.
Lastly, buying mining shares is a way to invest in gold through corporate operations. Picking the right share requires an investor to look at the cost to company of extracting the gold from the earth, and how management grows its operations. The risks of owning gold stocks include management’s inability to grow the company, operating delays or shut-downs, labour disputes, etc. There is usually a strong correlation between the commodity spot price and the company’s share price, but the management of the company can significantly add value.
Stockbroker and Portfolio Manager
Cheyne has spent the last 10 years working in London, holding numerous positions within Equity and Equity Derivatives at various Investment Banks. His main focus has been on South African and Emerging Markets and also gained good exposure to global equity markets and products. He completed both his BCOMM degree in Economics and his BCOMM. Honours in Financial Analysis and Portfolio Management at the University of Cape Town. After completing each of the rigorous exams, Cheyne became a CFA Charterholder in 2014.