All that glitters might be a bubble…..

All that glitters might be a bubble…..

It will not have escaped the attention of many who read the financial press that the star asset performance this year, apart from Tesla shares, has come from gold. We will leave Tesla for another briefing but the precious metal is up by a whopping 30% so far in 2020, against stock markets that are level at best, but most of them are down. Why is this?

Gold has been a ‘store of value’ for centuries so the fact that it is coveted now is nothing new. But as an asset class it is unusual since it pays no income and this actually makes it quite difficult to value. For stocks and bonds, because they pay dividends and coupons, it is possible to work out the future value of those income streams and value the underlying asset accordingly. This lack of income means that traditional valuation metrics used for other asset classes, do not work for gold. So the question of what the gold price should be cannot truly be determined and is set primarily by the market. Gold used to be pegged to the oil price and since gold is fungible, it was possible to work out how many ounces gold would need to be sold to buy a barrel of oil. In the current environment the answer is ‘not many’ but the link ended in 2019 so this is of little help to us.

But an absence of income can also give us insight into one of the main reasons the price has been so perky, which sounds paradoxical. It is. At the end of 2015, the gold price was around $1000 per ounce. At the same time, the 10 year UK government bond yield was 2%. It is now less than 0.2%. In other words, as the yield on low risk assets has fallen, the absence of an income on a comparable asset, like gold, matters less to investors and increases its relative attractiveness.

In times of uncertainty, gold has been regarded as a safe haven so events of 2020 so far have undoubtedly created demand. In addition, gold has historically been a good hedge against inflation. As we have said recently, there has been no inflation to worry about for years, but this might not always be the case, particularly with central banks printing money at such a rapid rate of knots.

So how much further can the gold price rise? This is tough to answer. The inflation expectations have probably not grown to such an extent so as to justify the all-time-high in the price, but that does not mean it can’t rise further. After all, even in a bubble, assets can get even more expensive. The economist John Maynard Keynes said as long ago as the 1930s that the market can remain irrational longer than an investor can remain solvent.

In previous asset bubbles, the tell-tale sign of an imminent reversal is when retail (private) investors get sucked-in. This happened in the gold market in1980 and 2013. So watch the news for unsuspecting investors leaving Hatton Garden with coat pockets full of sovereigns, and that will likely be the cue.

Dr Andrew Mann
Investment Director