Gold has been one of the tools in our armoury in the Real Return portfolio since early in the strategy’s history. It has typically been utilised as a hedge against a broad range of outcomes including central bank policy errors, the potential for rising inflationary pressures (which have clearly come to pass in abundance in recent quarters), tail-risk events and currency debasement, having the appeal of a real asset that cannot be manipulated by central banks.
Indeed, its benefits have been felt in different scenarios, although we recognise that it may not always act as an effective hedge and that often its return drivers can be varied and at times complex. However, in a well-diversified portfolio, designed to focus on capital preservation as well as generating long-term returns based on a cash + 4% target, we consider that gold merits a place with our stabilising layer.
Reviewing gold’s performance in the recent past, it was initially caught up in the Covid-induced sell-off but bounced back sharply, following the playbook of the period post-2008.
This time, the combination of a weakening US dollar, US interest rates pinned at very low levels, and a benign liquidity environment, provided a uniquely favourable backdrop for the precious metal. We built up a significant position in the portfolio, having added to our position through the first half of 2020, and benefitted from gold’s ascent, with the price exceeding $2000 at its peak in August that year.
On the outbreak of the Russia/Ukraine conflict in early 2022, we initially witnessed a surge in the gold price which asserted its tail-risk hedging properties. However, once the initial market fears had subsided, a strong US dollar and rising real yields weighed on the precious metal.
Despite this near-term weakness, which was less pronounced than we might have expected given the extent of the headwinds, we are maintaining our exposure. Taking full advantage of the flexibility that our mandate affords us, we reinitiated our position at the onset of the geopolitical crisis having previously sold our gold exposure to zero during the third quarter of 2021.
Our belief is that a sufficient number of risks remain, ranging from the desire by central banks to carry out an orderly unwinding of QE, persistent inflationary pressures as the cost-of-living soars with inflation likely to settle at a higher level in the medium term, and the potential for a more protracted Chinese slowdown to name but a few. This justifies a continuing role for gold in the portfolio, although our exposure has been calibrated to take account of the prevailing headwinds.