The surprising force behind gold’s rally

Gold and gold mining stocks have been some of the best performers this year. What’s behind that rally and can it continue? Heidi Richardson shares her take.

After a few years of losses, gold prices have risen 17% year-to-date as of April 25, making it one of the best-performing investments this year. Perhaps more remarkably, gold mining stocks are up nearly 78% during the same period, according to Bloomberg data.

The question now is: can the rally continue?

To begin, let’s take a look at the catalysts for the rally. Market expectations of slower global growth, a dovish Federal Reserve (Fed) and weakness in the U.S. dollar have been some of the major drivers behind the current rally.

Earlier in the year, when WTI oil prices dropped to a 13-year low, according to Bloomberg data, it dragged many other commodities with it. Gold, however, showed resiliency, and regained its status as a “safe haven” asset in turbulent times.

What is pushing gold higher

At the same time, gold has benefited from central bank policies and the level of real interest rates (in other words, the interest rate after inflation.) According to Bloomberg data, gold has typically performed best in environments in which real interest rates were low to negative (see the chart below). We are seeing stark examples of this with the current environment of negative interest rates in Japan and many parts of Europe.



When rates are rising, there is an opportunity cost for investors of gold since it doesn’t produce an income stream or pay a dividend. However in a negative rate environment, investors are paying money to issuers to “hold” their money. Rather than pay for that privilege, many investors opt for traditional stores of potential value like gold.

Thus, while it is true that global economic or political uncertainty, rising inflation and a weak dollar benefit gold prices, the most compelling argument for gold this year may center on central bank policy and the level of real interest rates. Notably, both the Bank of Japan (BOJ) and European Central Bank (ECB) have made it clear they will remain accommodative for the foreseeable future, and the Fed remains on hold.

In short, given the increased concerns of global growth slowing, oil price instability, the potential Brexit, and U.S. election, we think owning gold as part of a diversified asset allocation continues to be a sound approach.

Are you investing in gold or gold miners?

With respect to the gold miners, it is important to highlight the differences in investing in the physical commodity of gold versus buying stock in the companies mining the gold. Unlike gold ETFs that give investors exposure to trusts which hold physical gold, gold miner ETFs track the equity shares of companies that extract the precious metal from the earth.

Despite being highly correlated, gold miners are not a good substitute for physical gold from an asset allocation perspective. As a commodity, gold is diversifying to a portfolio, because it offers lower correlation to the equity market, and is a better inflation hedge. On the other hand, gold miners are essentially a leveraged play on gold prices and they have tended to magnify strength or weakness in gold prices.

The MSCI Global Gold Miners Index has rallied an incredible 76% this year, but much of the performance is due to the recovery in valuations: According to Bloomberg data, gold miner stocks were battered last year, with the index down 45% from its 2015 high. Now the stocks are not as attractive. At the same time, real rates have historically had little to no impact on equity returns.

However, we believe the future performance of gold and gold miners will depend in part on the Fed’s policy path. Should the Fed be more hawkish and raise rates in the next couple of meetings, both gold and the miners will likely underperform as investors position towards higher yielding assets. However, if real rates remain low, gold will continue to attract attention as a potential store of value which may offer a ballast to equity market volatility.

Investors interested in the physical asset of gold may want to consider investments such as IAU, the iShares Gold Trust. For those interested in the gold miners, consider RING, the iShares MSCI Global Gold Miners ETF.


Heidi Richardson is Head of Investment Strategy for U.S. iShares and a regular contributor to The Blog.

This information must be preceded or accompanied by a current prospectus. Investors should read it carefully before investing.

The iShares Gold Trust (the ‘Trust’) seeks to reflect generally the performance of the price of gold.
The iShares Gold Trust is not a standard ETF. The Trust is not an investment company registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Trust are not subject to the same regulatory requirements as mutual funds. Before making an investment decision, you should carefully consider the risk factors and other information included in the prospectus.

Investing involves risk, including possible loss of principal. Because shares of the Trust are intended to reflect the price of the gold held by the Trust, the market price of the shares is subject to fluctuations similar to those affecting gold prices. Additionally, shares of the Trust are bought and sold at market price, not at net asset value (“NAV”). Brokerage commissions will reduce returns.

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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