Since its peak in the aftermath of the 2008-2009 financial crisis period, gold has been stuck in a pretty steady slump, spiking here and there, as it has done in recent weeks, during moments of market insecurity, over events such as the unresolved Greek debt issue and the continued tensions in Ukraine and in the Middle East.
Should geopolitical risk increase further, and if it were to have repercussions for the financial markets, then gold, as the most traditional of safe haven investments, could get the support it needs to once again sustain an upward momentum.
“Gold is driven by financial stress and the longer-term driver that will make the most difference is financial stress in the U.S. economy,” said Joe Foster, manager of Van Eck’s International Investors Gold Fund. “Things are still pretty OK in the U.S., but I feel that could change, if not this year, then next.”
Foster, like other investors in gold, is more excited by the longer-term drivers of the asset class, which, they believe, will contribute in a meaningful way to a turnaround in the direction of gold and contribute to a rise in gold prices in the next couple of years.
Here’s what some investors had to say:
Joe Foster, manager of Van Eck’s International Investors Gold Fund, is expecting gold production to decrease either this year or next and go into a “slow and permanent decline, since there haven’t been enough new discoveries in this cycle to replace what has been depleted.”
This, he said, is a favorable long-term driver for gold and will greatly help in providing necessary support to the asset class.
Other investors think production growth is a positive. Malcolm Gissen, who manages the Encompass Fund, is expecting gold production to hit its peak in the middle of this year. Add to that the new technologies that larger mining companies have been investing in, “and we’ll see a significant increase in production,” he said.
A number of emerging market countries for whom gold is an important economic asset have also been introducing more favorable policies to support the mining industry, Gissen said, and this will further support production.
2. Low Correlation to Equity
Some have argued that in recent years, particularly with the advent of gold ETFs, the precious yellow metal has become more of a tradeable asset class, and though it was traditionally viewed as an investment to hedge against inflation, equities are now playing that role. Gissen, however, believes that gold continues to have an extremely low correlation to equities, U.S. equities in particular.
“There is always a case to be made for owning gold, particularly when there’s a flight to quality, but regardless, we think most people should own some gold in their portfolios because it has a very low correlation to domestic equities,” he said. “Most people over the past few years have increased their allocations to large cap equity and that is smart, but gold continues to have a low correlation to the equity market, and it is also something to own in case there’s a cataclysmic event that occurs, which can’t be ruled out, as that will be a huge catalyst for gold.”
3. Cheap Valuations, M&A Bode for Good Returns
In a low interest rate environment, large gold mining companies have been able to borrow and expand their operation, even as gold stocks and the metals sector have become seriously undervalued and extremely cheap.
“So you have to ask yourself at what point is it the right time to get out of the domestic stock market and put your money into the unloved but deeply discounted metals industry?” Gissen said. “Some of the contrarians are starting to do that now.” While Gissen has made good returns on large gold mining companies, he believes that junior mining companies that have “experienced management teams and operate in favorable political environments” offer good prospects. Many of these are also prime candidates for acquisition, he said, since they are strapped for capital and they’re looking for larger companies to bail them out.
Gold mining stocks have a very high correlation with gold and they don’t do well until gold does, Foster said, “but once we start seeing a more positive trend in gold, the returns on these stocks can be magnified.”
4. Continued strong demand from India and China is important
The two largest gold consuming nations, India and China, have done a great deal to support gold at its current price of $1,200 per ounce and will continue to play an important role going forward, Foster said.
“Asian demand is particularly important in a bear market as it places a floor under the market, and Asian buyers see the current price of gold as a bargain price to be buying at,” he said.
While increased financial risk would be the true driver of a gold bull market, the continued growth of emerging markets, the rise in middle class earning potential in India and China and the traditional value those societies attach to gold means that more people will be able to purchase it.