Factors influencing gold’s diversification benefits
Historically, gold has been a diversifying compliment to a traditional stock and bond portfolio throughout market cycles. Figure 1 illustrates that the correlation between monthly returns of gold and other asset classes over the past 20 years ranges from 0.3 to -0.3, suggesting the asset has low or negative correlations to most other major asset classes.
This diversification reflects a variety of factors unique to commodities generally, as well as those idiosyncratic to gold itself. As with most other commodities, gold has benefited historically from a weaker dollar environment, as its price is normally benchmarked in U.S. dollars. Additionally, late-cycle supply shortages and high levels of economic activity have also been supportive for commodities broadly.
However, gold’s historical reputation as a store of value, its role as a luxury good, and individual economic dynamics all expose the commodity to unique drivers of returns.
Figure 1: Gold is uncorrelated to other major asset classes
Source: Thomson Reuters, BlackRock, as of 6/4/2018. Notes: “Comdty” represents the Bloomberg Commodity Index. For indexes used please see the footnote at the end of the piece.1
Hedging attributes of gold
In the present environment, with higher equity volatility and geopolitical uncertainty, gold can play a role as a potential hedge. Additionally, during major market corrections over the past two decades, gold has successfully offset losses sustained from equities and higher-beta fixed income exposures (Figure 2).
Furthermore, given gold is priced in dollars, and typically appreciates in a falling dollar environment, it has for the greater part of several years performed in line with an increase in inflation expectations that has occurred in tandem with a decline in the value of the dollar (Figure 3).
However, since gold offers no cash flows, it is susceptible to an erosion of its value from rising interest rates as well as inflation. In an environment of runaway inflation and a weaker dollar, this argument would likely change, but as the dollar has recently been firmer as investors have repositioned for a slightly more aggressive Federal Reserve and after the 2017 dollar sell-off, this outcome seems unlikely. Therefore, as rates move higher in the U.S., the driver of that move – namely faster economic growth – suggests an environment where real rates are increasing and driving the move higher. As higher real rates offer better cash flows after inflation, they become more attractive relative to assets with no cash flows – like gold – leading to an environment where gold underperforms.
Figure 2: Losses sustained during financial crises were offset by gold appreciation
Source: Thomson Reuters, BlackRock, as of 6/27/2018. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Figure 3: Gold has risen with inflation expectations as the dollar has depreciated
Source: Thomson Reuters, BlackRock, as of 6/27/2018. The breakeven inflation rate represents a measure of expected inflation derived from the difference between the yields of a 5-Year Treasury Constant Maturity Securities and 5-Year Treasury Inflation-Indexed Constant Maturity Securities. Gold is represented by the LBMA Gold Price, a troy ounce index. Past performance does not guarantee future results.
Futures and ETP positioning sending mixed messages
After a strong year of inflows in 2017, when the largest gold exchange traded products (ETPs) pulled in just shy of $3 billion in assets, 2018 has already matched those inflows2 (Figure 5).
Uncertainty in markets and geopolitics have been the key drivers of this acceleration in flows. But looking forward, headwinds to the asset class could portend a shift in the second half of the year.
Gold wiped out its 2018 gains in the month of May, and is now trading at year-to-date lows, as of June 26th.3 It is not unusual to see a spring slowdown; May and June have posted back-to-back months of price declines on average over the last 30 years as demand from consumers in emerging markets for luxury goods containing gold picks up during the holiday season and during the Indian post-harvest wedding season.
In addition, investors in the futures market have been rapidly trimming their exposure to the metal (Figure 4). Hedge funds and other large speculators pared bullish bets on bullion to the lowest level in more than two years as the spot price fell below $1,300 an ounce.4
Figure 4: Futures position has moved sharply lower in the raw commodity since February
Source: Thomson Reuters, BlackRock, as of 6/27/2018. Gold price is measured by LBMA spot gold price for a troy ounce. Past performance does not guarantee future results.
Figure 5: Inflows into gold ETPs have kept a relatively strong pace despite futures slowdown
Source: Thomson Reuters, BlackRock, as of 6/27/2018.
In the shorter term, risks to consider include a potential rally in the dollar. Although the twin fiscal and current account deficits of the U.S. point to a weaker dollar in the longer-term, short-term growth prospects and current interest rate differentials are supportive for the dollar.
However, all things considered, gold is a unique commodity that has historically had low correlation to other assets, providing diversification benefits to investors. Given this, a modest exposure to gold could be suitable for some investors.
Article was originally on iShares.com
© 2018 BlackRock, Inc. All rights reserved.
1 SPX is represented by the S&P 500, Agg the Bloomberg Barclays U.S. Aggregate Bond Index, USD the Trade Weighted U.S. Dollar Index, ACWI the MSCI All Country World Index, EM the MSCI Emerging Markets Index, Comdy the Bloomberg Broad Commodity Index, and Gold is represented by the LBMA Gold Price, a troy ounce index.2 Source: BlackRock, as of 6/27/18.3 Source: CFTC, Thomson Reuters, as of 6/27/18. As measured by LBMA spot gold price for a troy ounce.4 Source: CFTC, Thomson Reuters, as of 6/27/18.
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iShares Bloomberg Roll Select Commodity Strategy ETF (CMDY)
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iShares Gold Trust (iShares Gold Trust)
This information must be preceded or accompanied by a current prospectus for the iShares Gold Trust. Click here for a current prospectus. Investors should read and consider it carefully before investing.
The iShares Gold Trust is not a standard ETF registered under the Investment Company Act of 1940 or subject to the same regulatory requirements as mutual funds or standard ETFs. Investments in the Trust is speculative and involves a high degree of risk.
Shares of the Trust are intended to reflect, at any given time, the market price of gold owned by the Trust at that time less the Trust's expenses and liabilities. The price received upon the sale of the shares, which trade at market price, may be more or less than the value of the gold represented by such shares. If an investor sells the shares at a time when no active market for them exists, such lack of an active market will most likely adversely affect the price received for the shares. For a more complete discussion of the risk factors relative to the Trust, carefully read the prospectus.
Following an investment in shares of the Trust, several factors may have the effect of causing a decline in the prices of gold and a corresponding decline in the price of the shares. Among them: (i) Large sales by the official sector. A significant portion of the aggregate world gold holdings is owned by governments, central banks and related institutions. If one or more of these institutions decides to sell in amounts large enough to cause a decline in world gold prices, the price of the shares will be adversely affected. (ii) A significant increase in gold hedging activity by gold producers. Should there be an increase in the level of hedge activity of gold producing companies, it could cause a decline in world gold prices, adversely affecting the price of the shares. (iii) A significant change in the attitude of speculators and investors towards gold. Should the speculative community take a negative view towards gold, it could cause a decline in world gold prices, negatively impacting the price of the shares.
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