By Cameron Judd
A precious metals bull market appears to have started, with the physical gold price gaining 23 per cent from its lows in September last year. Gold has recently breached the psychologically important US$2000/oz mark and, in Australian dollar terms, gold is nearing its all-time high price of $3000/oz.
Further gains in the gold price are expected in the face of aggressive US Federal Reserve rate rises, which is raising the risks of a recession. In the last three recessions since 2000, the gold price has outperformed US equities by 23 per cent on average, justifying its position as a hedge against financial turmoil.
A precious metals bull market appears to have started, with the physical gold price gaining 23 per cent from its lows in September last year.Credit: Trevor Collens
Slowing growth adds to the monetary policy complexity confronting central banks. If central banks can’t raise interest rates enough to tame inflation before triggering a recession, they could face increasing public pressure to reduce interest rates.
This could allow inflation to remain at elevated levels, raising the risk of stagflation: persistently high inflation combined with stagnant demand and rising unemployment. The top-performing assets during periods of stagflation since 1973 have been defensive and real assets, including gold, which has averaged a price gain of around 30 per cent.
With the threat of a recession, investors are confronted with a more complex investment universe and diversification can become more difficult. From the early 2000s until recently, equity and bond prices tended to move in opposite directions. Investors were able to build a diversified portfolio with only these two asset classes – commonly referred to as the 60/40 equity-bond portfolio.
However, with the breakout of inflation, this correlation has flipped from negative to positive, meaning the 60/40 portfolio is no longer well diversified. Investors need to add other low-correlation asset classes, such as gold, to achieve diversification, so when share markets fall the hit to their portfolios won’t be so hard.
Some of the strongest demand for gold has come from central banks, the most conservative investors of all. Net purchases of gold by central banks in 2022 totalled 1136 tonnes, an increase of 152 per cent on 2021. Not only was 2022 the thirteenth consecutive year of net central bank gold purchases, but also the second-highest level of annual demand on record going back to 1950.
A recent International Monetary Fund (IMF) working paper noted that fear of trade-restricting economic sanctions is pushing nations to diversify away from holding US dollars. It is therefore not surprising that emerging market central banks accounted for the bulk of net gold purchases in 2022.
Despite central banks buying up gold, other investors have been slow to react, but that is expected to change. Investment fund demand is best represented by gold-backed exchange-traded funds (ETFs). Whilst ETF demand is starting to increase, it remains near three-year lows. For this reason, once investor demand returns, there is significant potential for this additional demand to push the gold price considerably higher.
The good news for investors is that many gold miners are still undervalued and are trading at attractive multiples. Our preferred gold miners include those with minimal jurisdictional risk, disciplined management, and that generate positive cash flow, such as Northern Star and Gold Road. We also own a stake in Australia’s largest gold miner Newcrest, which this week approved a takeover bid from US gold giant Newmont, and we expect further consolidation of the Australian gold sector.
It is likely that gold will continue to draw more attention given the many benefits it offers investors.
- Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
Cameron Judd is Victor Smorgon Group’s portfolio manager for the gold strategy within the Global Multi-Strategy Fund.
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