Shining dawn: Gold

One of the many challenges of defending gold: Even its advocates can’t agree on why to own it. Many consider gold a hedge against inflation. Others suggest it is a long-term hedge against a depreciating dollar and/or stock market risk. However, what is clear is that gold can still hedge the most chaotic and uncertain of events: war. As Middle East tensions continue to ripple through markets, gold prices have rallied sharply.

Commodity performance YTD

We think that gold will continue to benefit from a geopolitical risk premium as a series of cascading crises is bringing significant uncertainty, volatility, and fragility to geopolitics and markets. War in the Middle East, Russia’s invasion of Ukraine, and U.S.-China tensions have accelerated geopolitical fragmentation. We have left behind the post-Cold War period of constructive and productive relations between the major powers.

Notwithstanding gold’s status as a store of value during times of geopolitical uncertainty, its recent gains have come in the face of tightening financial conditions and surging real interest rates, a traditional headwind for gold. This could signal a disproportionate rally as those headwinds dissipate. 

Assuming a continued softening in U.S. and global growth, the odds are the Fed has reached the end of its tightening cycle. If this proves true, flat to lower real rates should help gold, even more so if sticky inflation in Europe forces the European Central Bank (ECB) to continue to raise rates, pressuring the dollar.

US 10 year yield and gold price

Historically, gold has had a negative correlation with the dollar (more gold can be purchased when the dollar is weaker and vice versa)¹. The rate repricing narrative driving yields up has also lifted the U.S. dollar, which now trades at its highest level since last November against a basket of currencies. As such, expectations for a decline in the dollar, or even for it just not to increase anymore, could be another dynamic that leads investors to add gold to a portfolio.

Many emerging market central banks are also seeking to reduce their reliance on U.S. dollar reserves and China, India and Russia have all been adding to their gold holdings, a trend that has been pronounced this year.

Many investors view gold as an inflation hedge when, in truth, the relationship between gold and inflation is nuanced. As noted above, gold has tended to trade in closer relationship to real rates and the dollar vs. inflation per se. Notably, spot gold prices were rangebound in 2021, when U.S. inflation rates surged. Rather, gold does far better in periods of low growth and mild inflation – the “stagflation” that we see coming.

Moderation in inflation

While U.S. GDP data for Q3 showed that the economy grew 4.5% on the quarter (annualised) on strong consumption and trade, we don’t think it’s a sign of things to come. Consumers have funded spending from dwindling pandemic savings. We don’t see that lasting much longer. On top of this, and as the chart above makes clear, inflationary pressures haven’t faded completely. If the labour market remains tight and the last leg of the inflation fight proves to be the toughest, that would be bad news for both stocks and bonds. However, this environment of slowing economic growth and stabilising real rates would leave gold poised for a longer-term rebound.

New regime, new market approach. That’s been BlackRock’s mantra when it comes to portfolio construction. Those using the traditional approach to portfolio construction will have to tolerate more risk to achieve a similar return. Bonds aren’t offering the same cushion from stock slides they used to. Long-term fiscal concerns and persistent inflation are making bonds a riskier asset today. All this has cast doubt on the future of the traditional 60/40 portfolio. Our research shows that investors are better off when they line their portfolio with gold.

It's notable that many of BlackRock’s model portfolios globally, maintain exposure to physical gold for diversification purposes.

Gold historically has a low correlation with broad global stock and bond exposures:

Low correlation with other asset classes

In the last 10-years, monthly price correlation between gold and the S&P ASX 200 was 0.10², meaning there was virtually no correlation between stocks and gold. As such, getting granular with gold can help improve the trade-off between risk and return, and the correlation between assets in portfolios.

Confronted with geopolitical uncertainty and a lack of clarity in earnings, markets look set to remain volatile and economic growth uncertain. All this makes the current moment a golden opportunity for diversification.