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Gold has had one of its more excitable runs since the start of the year. It surged so much in the wake of the Iran airstrikes that it even drew the attention of the broadsheet financial press. So naturally, the price was bound to tank shortly afterwards. Which is precisely what happened this morning. If you’re a gold investor, you might be fretting that gold’s high point for 2020 has already come and gone. I wouldn’t worry.
I have two thoughts about the market reaction to the conflict between the US and Iran. If I express them too quickly, it might sound like they contradict one another. So let me explain in detail.
The market is right not to panic about Iran, but it’s still complacent
My first thought is that markets are broadly right to avoid panicking too much. Tension in the Middle East is not new. Beyond the natural drama – which has been exaggerated by Donald Trump’s penchants for unpredictability and showmanship – there’s nothing game-changing here. Iranian oil is largely locked out of the market at the moment by US sanctions. The stuff they do sell is going to China. Barricading the Strait of Hormuz would thus hurt their biggest customer. So if you take a deep breath, look beyond the shouting about World War III and all the rest of it (much of which is motivated by a borderline unhinged hatred of Trump), then nothing has fundamentally changed in the last couple of weeks to make markets panic. It therefore makes sense that gold and oil – the classic “OMG scary stuff is happening, what do I do!?” go-to assets – are falling back to where they were before the US killed Iranian general Qasem Soleimani.
My second thought is that the speed with which this reversion to “everything is A-OK” has happened is indicative of a high level of complacency. It’s one thing to take a realistic view of things; it’s quite another to decide that the latest incidents deserve absolutely no change to the risk premium in markets at all.
What does all that mean in practice for you, the investor?
I’d just say that I think it’s still worth owning oil and gold in your portfolio. This latest excuse for a surge higher was always likely to falter. But there are plenty of other reasons to hold these assets. I’ve talked about oil a fair bit in the last few months so I won’t focus on it here (and there’s more on it in the forthcoming issue of MoneyWeek magazine, out tomorrow). But I’d like to take a closer look at gold.
The fundamentals are bullish for gold
Just a few days ago, gold hit a near-seven-year high. April 2013 marked the point where the long stasis afflicting gold after its 2011 high point turned into a properly nasty bear market. This week’s high point saw it claw back into that rarified territory. The Iran conflict gave it a boost. But it’s worth noting that gold was already doing well. All last year, it made gains. And that was in the face of a relatively strong – if broadly static – US dollar. As Louis-Vincent Gave of Gavekal points out, “it is possible to make a constructive argument for gold simply on future supply and demand.”
One point is that central banks “are back to buying gold.” Negative bond yields mean that gold – which at least yields a little less than 0% (after storage costs), rather than a lot less – suddenly looks like an acceptable reserve asset.
There’s also the fact that gold miners – which have been generally appalling investments – are in the “merge and preserve capital” phase of their evolution, rather than the “throw as much money as possible at digging holes and wooing stock promoters” phase. When miners would rather buy each other than open new mines – even though the gold price is actually pretty high compared to history – you have a recipe for restricted physical supply. It also indicates that sentiment is not overly bullish. As Gave puts it: “It’s a textbook sign of a bottom in any given commodity’s cycle.”
What if you’re a sterling investor?
There is, of course, the question for sterling investors: if the pound is going to get stronger (which may or may not happen, but it’s certainly fair to argue that the pound is undervalued), then does it make sense to have much exposure to gold?
My take on this is that you probably shouldn’t worry about it too much. It would be daft to have 100% of your portfolio in any one asset. In fact, I think that gold and sterling-denominated assets (such as UK equities) will probably work well in a portfolio together. Sterling, for example, is historically a “risk-on” asset – when investors feel bullish, the pound tends to get stronger, but gold tends to suffer. So it’s all good for diversification. And given that the pound does need to play catch-up, it’s quite possible to think of scenarios where both the pound and gold go up in tandem.
In short, you should own gold for all the usual reasons – it’s a good diversifier in a portfolio that otherwise consists of equities, bonds, property and cash, so there should always be a bit of it in your portfolio.
However, I also think that it’s currently in a bull market, and that this will continue. So if you are an active investor, you might want to have a higher asset allocation to gold than you normally would. And you might want to consider gold miners too (my colleague Dominic suggested a few to investigate in this MoneyWeek piece from last year).