AEYSHA SAMSODIEN: Gold may be shiny, but we’re not buying

The gold price has defied investor expectations in the first quarter of the year, outperforming global equities and gaining about 10% to hit a new record high of $2,251.37/oz on the last day of March before breaking through the $2,400 level on April 12.

Traditionally, gold has an inverse relationship with real global yields. As global yields rise (as they have since March 2022 in the US), demand for gold should theoretically wane as its non-interest-paying nature hurts its competitive position against cash in the short term due to carry trade opportunity costs.

Instead, during this long rate hiking cycle gold has risen from about $1,600/oz in October 2022 (albeit with some corrections) to new records. Now, with interest rates having plateaued but still likely to remain high for longer than most had projected, the gold price continues to behave anomalously, still attracting good support.

What has happened to break the traditional relationship between the gold price and global yields? Geopolitical risks have risen due to the ongoing wars, starting with the Russian invasion of Ukraine and then the outbreak of hostilities in the Middle East, both of which have the potential to escalate. This has helped sustain the demand for gold, traditionally a safe-haven asset.

Another factor has been the macroeconomic uncertainty created by high global inflation and concerns over the global recovery from the pandemic lockdowns, and more recently worries over the outcomes of the numerous national elections in 2024.

Unusually high central bank buying of gold has also contributed to the precious metal’s record highs, notable among them the People’s Bank of China, Central Bank of Turkey and the Reserve Bank of India. In 2022 and 2023 more than 1,000 tonnes of gold was purchased, compared with the historical average of about 400 tonnes. Their reported primary reasons for purchases have been gold’s value in times of crisis, and its benefits of diversification and being a long-term store of value and inflation hedge.

Causing crisis

Stand-out buyers have been the People’s Bank of China and Chinese investors during the period from November 2022 to date, when the People’s Bank resumed reporting on its gold reserves. The Chinese central bank’s official gold tonnage rose about 14% over the period, including strong buying in the first quarter of 2024.

Chinese investors have turned to gold investments such as exchange traded funds (ETFs) and gold coins amid the country’s economic slowdown and financial instability, causing a crisis in the property sector, a weaker yuan and equity market losses. Chinese and Hong Kong stocks lost nearly $5-trillion in market value in the past three years, CNBC reports.

The Asian demand for gold ETFs appears to have helped offset sales of gold ETFs from Western investors. Historically, the rising price of gold has generally corresponded with higher ETF purchases in developed markets, but this has noticeably not been the case in the most recent period, resulting in another breakdown of historical relationships.

Gold bullion can be viewed as a default, uncorrelated and unanchored asset, the value of which is not driven by fundamental characteristics such as supply-demand dynamics or cash flows. This gives it a role to play as a portfolio diversifier, but its lack of cash flow tends to preclude gold bullion from our valuation-based investment approach. It also lacks leverage to the gold price, which is one of the benefits of gold mining shares.

Though gold equities can be valued on cash flow (in theory at least), the fundamental driver of it — the gold price — undermines this. Equally, SA gold mining companies have historically low returns on capital and poor cash flows (due partly to the relatively short lifespan of gold ore bodies, which require constant reinvestment or new asset acquisitions). This further impairs our view of the investability of gold mining shares.

Encouraging profile

M&G’s underweight portfolio positioning reflects this somewhat sceptical view of gold. However, given the uncertainties mentioned above, the prevalence of central bank gold buying and the outlook for possible interest rate cuts, there is a probability that the gold price will remain high. Therefore, given our focus on risk management, our house view portfolios do have exposure to the sector but are underweight, and we are constantly reassessing this positioning.

Within the sector, we prefer to hold AngloGold and Gold Fields, and are cautious on Harmony. AngloGold has the encouraging profile of improving production combined with lower costs over the next few years. This will be driven by the operational recovery of its Obausi mine in Ghana, and in the medium term organic growth from its North-American assets, which have a low cost base.

Gold Fields will benefit from its Salares Norte project, which is ramping up. We are cautious on Gold Fields over the medium term as the company will need to acquire new projects to maintain its production profile, and this increases capital allocation risk.

Harmony is highly exposed to the rand gold price given that most of its gold is produced in SA. Over the past few years the quality of its asset profile has improved, with higher-cost, older mine production coming out and newer, lower-cost assets being embedded in the portfolio.

Unfortunately, Harmony has a pipeline of projects, both local and international, that it needs to invest in over the next decade, and these will offset the cost decline in its current core operations.

• Samsodien is portfolio manager at M&G Investments.