Asset Allocator's Soapbox: David Coombs

David Coombs, head of multi-asset investments at Rathbone Unit Trust Management, on the prospects for gold.

Gold continues to cause controversy. It has always mesmerised; it has always provoked debate about its credibility as a real asset, and no more so than now. In recent weeks, its credentials have been placed under sharp scrutiny as the market focuses on the global implications of quantitative easing and the potential for further uncertainty.

Notwithstanding the fact that gold has had a strong run and may be due a short-term technical correction, strategically we maintain our combined weighting of 7% across the multi-asset portfolios. We will look to buy on technical corrections over the medium term, and here’s why:

Conventional gilts have been overvalued for some time, although this will not stop false demand creation in the short term. Nevertheless, government securities have been softer in recent weeks. With inflation sticky on both sides of the Atlantic, and the likelihood of more quantitative easing, yields, particularly at the longer-end of the curve, remain vulnerable.

Essentially, we are wary of a 1994-style back-up in yields, caused by a shock rise in interest rates from the Federal Reserve. The end result then was that bond investors incurred equity-like losses. This type of back-up is not necessarily imminent; however, we believe that the market is only just realising that inflation risk is firmly to the upside and rearing its head sooner than anticipated. Policy error is therefore very possible.

In terms of competitive devaluation, gold seems like a sensible store of value and currency hedge. Dollar weakness will provide price-support, as will central banks diversifying back into gold, and overseas investors who are looking for an alternative to Treasuries and euros. In some respects, there is an element of ‘don’t fight the Fed’ here.

In recent months, we have also seen demand being created by new funds with gold-hedged share classes.

The opportunity cost of holding gold is at its lowest for a generation in our opinion, meaning with interest rates close to zero, it is relatively inexpensive in terms of carry.

Strategically, western central banks are now in a print-money mindset. We may well see more quantitative easing (QE) – QE3 or even QE4, as governments try to avoid a deflationary spiral at any cost. Subsequent inflation and Dollar debasement can only be a positive for gold.

We are fully aware that the true ‘worth’ of gold will only become apparent in an extreme environment – like the performance of so many assets during these exceptional times, history is not necessarily a guide to the future. For example, historically, gold has been inversely-correlated with risk assets, but this relationship is breaking down, and over the next 12 months, we should see a positive correlation develop with risk assets.

When sentiment turns, however, we expect gold to be the more resilient of the two, and to provide a relative value trade over other, more cyclical commodities such as copper (the latter of which has also hit an all-time high).

Gold might face a headwind if the Dollar strengthens significantly; should the QE argument become less and less convincing; or a systemic shock, (from the Eurozone, for example), drives safe-haven buying. One thing that is certain, however, is that it is difficult to put a genie back in the bottle. Like it or not, gold’s place in the investment psyche is here to stay.