Expanding Horizons With Gold

|
Includes: CMDY, IAU, IAUF
by: Christopher Dhanraj

Summary

Episodes of higher volatility in 2018 have led many investors to search for alternative drivers of returns and downside protection.

We find that the low correlation of gold versus other traditional asset classes provides investors with a diversifying tool in constructing a multi-asset portfolio.

The investment function of gold as a defensive asset and store of value also helps it serve as a potential hedge against stock, bond, and currency volatility.

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

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

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

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

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

Inflows into gold ETPs have kept a relatively strong pace despite futures slowdown

Source: Thomson Reuters, BlackRock, as of 6/27/2018.

Conclusion

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.


Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses, which may be obtained by visiting the iShares Fund and BlackRock Fund prospectus pages. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

Negative changes in commodity markets could have an adverse impact on companies the Fund invests in. The price of the equity securities of companies engaged in mining and the price of the mined metals may not always be closely linked. Worldwide metal prices may fluctuate substantially over short periods of time, so the Fund's share price may be more volatile than other types of investments.

Commodities' prices may be highly volatile. Prices may be affected by various economic, financial, social and political factors, which may be unpredictable and may have a significant impact on the prices of precious metals.

Diversification and asset allocation may not protect against market risk or loss of principal.

This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

This document contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.

This material is provided for educational purposes only and is not intended to constitute investment advice or an investment recommendation within the meaning of federal, state or local law. You are solely responsible for evaluating and acting upon the education and information contained in this material. BlackRock will not be liable for direct or incidental loss resulting from applying any of the information obtained from these materials or from any other source mentioned. BlackRock does not render any legal, tax or accounting advice and the education and information contained in this material should not be construed as such. Please consult with a qualified professional for these types of advice.

iShares Bloomberg Roll Select Commodity Strategy ETF (CMDY)

iShares Gold Strategy ETF (IAUF)

Each Fund is actively managed and does not seek to replicate the performance of a specified index. The Fund may have a higher portfolio turnover than funds that seek to replicate the performance of an index.

Each Fund is a commodity pool, as defined in the Commodity Exchange Act and the applicable regulations of the Commodity Futures Trading Commission, or "CFTC," and is managed by its Advisor, BlackRock Fund Advisors, a commodity pool operator registered with the CFTC.

Each Fund's use of derivatives may reduce the Fund's returns and/or increase volatility and subject the Fund to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. Commodity futures trading may be illiquid. In addition, suspensions or disruptions of market trading in the commodities markets and related futures markets may adversely affect the value of the Fund. Certain derivatives may give rise to a form of leverage and may expose the Fund to greater risk and increase its costs. To the extent that the Fund invests in rolling futures contracts, it may be subject to additional risk. An increase in interest rates may cause the value of fixed-income securities held by the Fund to decline.

Investing in commodity-linked derivatives and commodity-related companies may increase volatility. Price movements are outside of the Fund’s control and may be influenced by weather and climate conditions, livestock disease, war, terrorism, political conflicts and economic events, interest rates, currency and exchange rates, government regulation and taxation. Commodity futures trading may be illiquid. In addition, suspensions or disruptions of market trading in the commodities markets and related futures markets may adversely affect the value of the Fund.

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.

Shares of the Trust are not deposits or other obligations of or guaranteed by BlackRock, Inc., and its affiliates, and are not insured by the Federal Deposit Insurance Corporation or any other governmental agency. The sponsor of the trust is iShares Delaware Trust Sponsor LLC (the “Sponsor”). BlackRock Investments, LLC ("BRIL"), assists in the promotion of the Trust. The Sponsor and BRIL are affiliates of BlackRock, Inc. Although shares of the iShares Gold Trust may be bought or sold on the secondary market through any brokerage account, shares of the Trust are not redeemable from the Trust except in large aggregated units called "Baskets". Only registered broker-dealers that become authorized participants by entering into a contract with the sponsor and the trustee of the Trust may purchase or redeem Baskets.

©2018 BlackRock, Inc. All rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, BUILD ON BLACKROCK, ALADDIN, iSHARES, iBONDS, iSHARES CONNECT, FUND FRENZY, LIFEPATH, SO WHAT DO I DO WITH MY MONEY, INVESTING FOR A NEW WORLD, BUILT FOR THESE TIMES, the iShares Core Graphic, CoRI and the CoRI logo are registered and unregistered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

530496