by Heidi Richardson, BlackRock
Gold and gold mining stocks have been some of the best performers this year. What’s behind that rally and can it continue? Heidi Richardson shares her take.
After a few years of losses, gold prices have risen 17% year-to-date as of April 25, making it one of the best-performing investments this year. Perhaps more remarkably, gold mining stocks are up nearly 78% during the same period, according to Bloomberg data.
The question now is: can the rally continue?
To begin, let’s take a look at the catalysts for the rally. Market expectations of slower global growth, a dovish Federal Reserve (Fed) and weakness in the U.S. dollar have been some of the major drivers behind the current rally.
Earlier in the year, when WTI oil prices dropped to a 13-year low, according to Bloomberg data, it dragged many other commodities with it. Gold, however, showed resiliency, and regained its status as a “safe haven” asset in turbulent times.
What is pushing gold higher
At the same time, gold has benefited from central bank policies and the level of real interest rates (in other words, the interest rate after inflation.) According to Bloomberg data, gold has typically performed best in environments in which real interest rates were low to negative (see the chart below). We are seeing stark examples of this with the current environment of negative interest rates in Japan and many parts of Europe.
When rates are rising, there is an opportunity cost for investors of gold since it doesn’t produce an income stream or pay a dividend. However in a negative rate environment, investors are paying money to issuers to “hold” their money. Rather than pay for that privilege, many investors opt for traditional stores of potential value like gold.
Thus, while it is true that global economic or political uncertainty, rising inflation and a weak dollar benefit gold prices, the most compelling argument for gold this year may center on central bank policy and the level of real interest rates. Notably, both the Bank of Japan (BOJ) and European Central Bank (ECB) have made it clear they will remain accommodative for the foreseeable future, and the Fed remains on hold.
In short, given the increased concerns of global growth slowing, oil price instability, the potential Brexit, and U.S. election, we think owning gold as part of a diversified asset allocation continues to be a sound approach.
Are you investing in gold or gold miners?
With respect to the gold miners, it is important to highlight the differences in investing in the physical commodity of gold versus buying stock in the companies mining the gold. Unlike gold ETFs that give investors exposure to trusts which hold physical gold, gold miner ETFs track the equity shares of companies that extract the precious metal from the earth.
Despite being highly correlated, gold miners are not a good substitute for physical gold from an asset allocation perspective. As a commodity, gold is diversifying to a portfolio, because it offers lower correlation to the equity market, and is a better inflation hedge. On the other hand, gold miners are essentially a leveraged play on gold prices and they have tended to magnify strength or weakness in gold prices.
The MSCI Global Gold Miners Index has rallied an incredible 76% this year, but much of the performance is due to the recovery in valuations: According to Bloomberg data, gold miner stocks were battered last year, with the index down 45% from its 2015 high. Now the stocks are not as attractive. At the same time, real rates have historically had little to no impact on equity returns.
However, we believe the future performance of gold and gold miners will depend in part on the Fed’s policy path. Should the Fed be more hawkish and raise rates in the next couple of meetings, both gold and the miners will likely underperform as investors position towards higher yielding assets. However, if real rates remain low, gold will continue to attract attention as a store of value offering a ballast to equity market volatility.
Investors interested in the physical asset of gold may want to consider investments such as IAU, the iShares Gold Trust. For those interested in the gold miners, considerRING, the iShares MSCI Global Gold Miners ETF.