The market has just come through a year when the classic 60-40 portfolio model (60% equities/40% fixed income) has come under strain, so it makes sense to think about diversification and alternative investments.

 

To my mind, the monetary metals of gold — and silver too — are attractive as alternatives because they are uncorrelated to traditional stock and bond markets, hold their value as real money and trade in highly liquid markets.

 

Gold and silver are unique in that they are partly driven by supply and demand factors (commodity dynamics) but are more sensitive to changes in monetary policy and forward inflation. This is important in an environment rife with uncertainties around interest rates and central bank policy.

 

Gold in dollars posted a small decline (-0.3%) in 2022, a turbulent year for equities (S&P 500 -18%) and fixed income (Bloomberg US Corp Bond Index -15.8%). 

Safe haven

Gold and silver are considered to be safe-haven assets. They are apolitical money and stores of true value – unlike currencies printed by governments. The gold price typically moves inversely to real interest rates, or the yield on a bond after accounting for inflation; in this way, it can help to defend a portfolio against the effects of inflation.

 

Academic studies show that a 2%-5% holding in gold, as a fixed allocation, is optimal for portfolio diversification purposes. I believe that many investors are under allocated to gold and that 2023 may prove to be an interesting year for the yellow metal.

 

Central banks have over few quarters raised rates sharply and expresses unwavering commitment to tighter monetary policy. My view is that banks including US Federal Reserve (Fed) will have to reverse course and loosen rates — which would be supportive of gold. In fact, there’s a battle going on over the narrative for monetary policy. Financial markets are suggesting that central banks will have to begin easing this year as recession takes hold, while central banks are saying they’re going to keep on tightening to finish off inflation. 

Finding momentum  

The price of gold touched $2,000/oz last March then fell back to around $1,600/oz in September. It then began marching upward again and is now around $1,900/oz — even stronger in other currencies. I believe this latest dollar gold move reflects the expectations for a change in central bank policy and slowing economic growth. When the Fed pivot comes, I believe it will create a positive environment for gold as dollar real interest rates weaken, and this will in turn provide momentum as more investors look to monetary metals. We could be off to the races, in my view.

 

Central banks have been increasing their gold holdings at the same time as vowing to remain hawkish on rates. Some of the world’s most important central banks hold a significant proportion of their total reserves in gold. 

Central banks buying 

According to the World Gold Council, central bank demand for gold more than doubled in 2022 to 1,136 tons – the most since 1967 — from 450 tonnes the year before. Purchases in Q4 2022 were 417 tonnes and in 2H more than 800 tonnes. Turkey, China, Egypt and Qatar were among the biggest buyers, based on the data available. 

Central Bank Gold Purchases (Tonnes, Q/q)

Source: Metals Focus, Refinitiv GFMS, World Gold Council via World Gold Council, as at 31 December 2022.  

I believe that market and geopolitical volatility have pushed central banks to increase their stockpiles. And with inflation persisting, many central banks are storing their wealth in gold rather than cash. It’s clear to me that these institutions see gold as liquid, uncorrelated, apolitical, risk-free and a proven store of value. I think they’ve made the right call on gold allocation, maybe less so on rates.  

The value of active minds: independent thinking

 

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

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