Gold seems to be in the midst of a prolonged bull run, but perhaps we are witnessing a more structural regime change, where asset correlations fall apart and this commodity has a more permanent role to play. If so, you could consider everything else is being devalued relative to gold, Ruffer’s Alexander Chartres says
The Hindu Festival of Lights, Diwali, is a time of the year when many people traditionally purchase gold to honour an age-old tradition and, hopefully, gain a bit of luck in the process.
But the lines outside gold shops around the world this month are not merely the result of a religious tradition. The gold price – despite the pullback in the past few days – has been on a tear, clocking in at well over US$4000 an ounce. Just five years ago, it was still hovering around only US$1500 an ounce and even last year, the gold price was still moving around US$2000.
When you're thinking about growth, the assets that you're going to want to own in a world that has more volatile inflation and is more prone to supply shocks, commodities are probably a useful part of that
Retail investors might be chasing momentum, but Alexander Chartres, a United Kingdom-based fund manager with Ruffer, sees structural reasons why gold has done so well in recent times. He points to a regime change, where inflation is more volatile and is likely to remain higher for some time to come.
In this situation, even institutional investors might want to take an exposure to gold.
“In a more inflation-prone environment, commodities traditionally are a good asset to own. So when you’re thinking about growth, the assets that you’re going to want to own in a world that has more volatile inflation and is more prone to supply shocks, commodities are probably a useful part of that,” Chartres says in an interview with [i3] Insights.
Although he thinks inflation will be higher for longer, he doesn’t think it will skyrocket anytime soon. He sees a longer-term trend where the 2 per cent rate provides a soft floor, rather than a ceiling, as previously has been the case. And this conviction has been borne out in recent years, he says.
“If you look at US core CPI over the last five years, it’s been 3 per cent or more for that whole period,” he says.
Shifting Asset Correlations in a More Volatile Inflation Era
But the higher level of inflation is only one aspect of the current market environment; inflation volatility is another characteristic of this era and this has significant implications for the stock/bond correlation, he says.
“The reason we focus on volatility is that it destabilises asset correlations and that’s what really matters for investors. It really matters for the stock/bond correlation, because more volatile inflation, and particularly higher and more volatile inflation, makes bonds a much less reliable offset for equities,” he says.
This is one of the reasons why investors of all ilk have been flocking to gold.
“We think that bonds will continue to be an unreliable portfolio hedge, and that’s one of the reasons that people have to think more about things like commodities, gold and derivatives,” he says.
Taking Exposure to Gold, But Not Always Via Bullion
Ruffer has long held an exposure to gold, but the company varies in the way in which it allocates to the commodity. Sometimes it holds gold bullion, sometimes gold miners, and sometimes both. It depends on where the relative value looks best, Chartres says.
“We have had gold exposures during my time at Ruffer. The last 15 years, we’ve always had gold in some shape or form,” he says.
“In the last couple of years, we’ve chosen to focus almost all of our precious metals exposure in gold mining equities, because these offer significant beta – usually one-and-a-half to two times to the gold price.
“What gold has been doing this year … it has been more than two times, and so it’s been a huge driver of portfolio returns for us,” he says.
But as prices continued to rise this year boosted by more speculative fervour, Ruffer has been taking profit aggressively.
In an era of regime change, you would expect very substantial moves, and you could argue that pretty much everything else is being devalued relative to gold
“Gold miners are still sensitive to increases in energy costs and if you’ve got a sustained counter-trend rally in the dollar, for example, that would also be difficult in the short term,” he says.
Besides, the gold price is now looking expensive on pretty much every metric. Although there is no cash flow in physical assets – the traditional measure to determine the dearness of companies – gold looks expensive against other commodities, such as oil or silver, and even against the historical relationship with inflation.
Yet, it still looks good against equities, he says.
“Almost all of these look very stretched now – hence our profit-taking – but against equities, gold still looks relatively inexpensive,” he says.
The Long-term Case for Gold
Although the recent strength of the gold price has provided an opportunity to take profit, over the longer term, Chartres expects it to continue to play an important role in investor portfolios as a diversifier to other assets. Ruffer’s gold mining exposure is held alongside a range of other positions in their multi-asset absolute return strategy, including equities, bonds, other commodities, foreign exchange and protective derivative positions.
“If you were to distil the Ruffer world view about this more inflation-prone and volatile era of fragmentation in the world order, central bank politicisation and activist governments using fiscal [policy], then gold would be a key asset,” he says.
“It is enjoying a structural bid, because of inflation risk, fiat debasement, inflation volatility, geopolitical volatility and fragmentation, concerns about the US dollar and demand for reserve diversification, and the failure of conventional portfolio protective assets, particularly bonds. The list goes on and on.
“We think all the structural reasons for gold are still intact. It has obviously run very hard and the gold price action is telling you that the regime change we have been talking about for years has arrived.
“But in an era of regime change, you would expect very substantial moves, and you could argue that pretty much everything else is being devalued relative to gold,” he says.
This article was sponsored by Ruffer. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.