A major holding in gold could become standard in portfolios worldwide as investors – institutional and retail – hedge against the potential for a sharp rise in inflation in the next few years. Diversification Some wealth and fund managers are looking at replacing part of their bond holdings with bullion, writes William McInnes.
Asignificant holding in gold could become standard in portfolios worldwide as investors – institutional and retail – hedge against the potential for a sharp rise in inflation in the next few years.
Advisers have generally prepared for unexpected inflation by allocating a percentage of portfolios to short-term bonds, enabling managers to frequently roll over those bonds at high interest rates, helping investors keep up with inflation.
But wealth and fund managers are looking at replacing at least part of the bond holding in portfolios with gold.
‘‘We’re looking at it on a longer-term trend ourselves because when bonds are paying so little, you need to start looking at that,’’ says Hamilton Wealth Partners managing partner Will Hamilton.
Positive, letalone high,yields onshort-term bonds are increasingly rare across the globe, meaning investors aren’t getting the same benefit from holding debt they once did.
In Japan and Europe’s largest markets, two-year bonds are negatively yielding, meaning investors will receive a smaller amount at the bond’s maturity than what they paid, essentially meaning borrowers are paying for the privilege of taking on debt.
Even in Australia, the two-year yield is just 0.26 per cent, with the front end of the yield curve largely pinned down by the Reserve Bank of Australia’s yield curve control.
While gold doesn’t receive the same regular income as bonds, it still acts as a hedge against inflation, and with the potential for inflation to rise unchecked by central banks, its price could remain well supported.
The US Federal Reserve indicated in late August that rates were likely to stay lower for longer, even if inflation did creep higher, leading many to question if holding bonds in a portfolio is as wise a decision as it once was.
Break-even rates – a market-based measure of expected inflation over a given period – have risen sharply since March on expectations that inflation will not be severely affected after COVID-19 as central banks loosen the reins.
‘‘Stimulus is going to continue for some time and you’re still going to see QE keeping bonds down artificially, so I think that there is a risk of inflation coming back in,’’ says Hamilton. ‘‘It’s going to be good for gold and not so good for fixed income in the short term.’’
In late August, the $US16 billion ($22 billion) Ohio Police & Fire Pension Fund approved a 5 per cent allocation to gold to hedge against the risk of inflation. Typically, pension funds have a much lower holding in gold, with less than 20 per cent of institutional investors having a gold allocation.
Portfolios have traditionally been weighted on a 60:40 basis, with 60 per cent in equities and 40 per cent in bonds. But some investors are tipping that a 60:35:5 portfolio, with a 5 per cent weighting in gold, could become the new normal.
‘‘You’re starting to see pension funds change that very consensus allocation of capital to include gold,’’ says Tribeca Investment Partners Asia chief executive Ben Cleary.
‘‘There are always outliers and funds doing their own thing, but the industry tends to follow one another and you might well be looking at a new consensus model that includes a lot higher level of gold.’’
Cleary says he’s seen broad signs across the market that a strong change is underway, with Warren Buffett’s Berkshire Hathaway buying a stake in Toronto-based gold miner Barrick Gold in mid-August.
‘‘The private high net worth individuals look like they’re adding gold, pension plans look like they’re adding gold, and institutional investors look like they’re adding gold,’’ says Cleary.
Any substantial move towards a higher weighting of gold across the industry would have huge ramifications for the price of the precious metal, with only a limited supply available.
‘‘If you look at all the stocks, all the ETFs, all the physical gold bars, futures markets, you wouldn’t be able to implement [a 5 per cent allocation],’’ says Cleary. ‘‘Lots of people have been making the point that even if it’s 1 per cent, that’s bigger than the entire gold equity market.’’
Unlike bonds, gold delivers no income, no dividends and costs money to store. But while storage can be an issue for large institutions, retail investors can easily gain exposure to the commodity through ETFs.
‘‘Investors are first and foremost buying gold and gold miners as safe-haven assets, which is continuing to push up the gold price and we are likely to see further gains,’’ says VanEck head of Asia Pacific Arian Neiron.
‘‘There are many out there who believe systemic risks are growing because of the unsustainable nature of the US Fed’s QE program and the huge and unsustainable level of US government debt. These risks are growing.’’
He suggests investors are less concerned about hedging against inflation, however, and more interested in its defensive qualities in an uncertain environment.
‘‘Until greater certainty emerges, investors will keep buying gold and gold miners. People aren’t buying gold as an alternative to bonds, or even for the high price,’’ says Neiron.
‘‘They are buying it as a defensive asset with low correlation to equities – not just as an inflation hedge and not as an alternative to bonds.’’
There’s no doubt gold’s stellar run this year has been driven by huge uncertainty, however the state of the bond market after COVID-19 means it could well continue.
‘‘I think that gold went into portfolios based on COVID-19 fears, but we will see whether it stays,’’ says Hamilton. SI