FIFI PETERS: This segment is brought to you by Allan Gray Long Term Investing. Let’s shift the focus back to inflation, because it is the global buzzword right now, and everyone is worried about it. In fact, I just checked my Twitter and somebody was just talking about the cost of living crisis and how to navigate it.
But everyone is worried about it. Central banks are worried about it. That’s why they’re raising interest rates quite aggressively, trying to bring it down and investors are also pretty worried and they are trying to find various means and ways to protect your returns from being eaten away by inflation.
One of those places [where] investors are running for cover to protect returns is gold, and to discuss why gold is considered a safe bet during periods of high inflation I’m joined by Jithen Pillay, who is an investment analyst at Allan Gray.
Jithen, thanks so much for your time. Let’s start from the very beginning. Why does gold tend to be a safer place to hide in periods of economic turbulence or high inflation?
JITHEN PILLAY: Hi. Good evening, Fifi. If we look back over the very long term, and we can go back to the … early 1970s effectively – when gold lost its peg to the dollar, gold had been highly correlated with negative real interest rates. By ‘real interest rates’ I mean longer interest rates, less inflation. Why has that been the case? Well, if you think about financial assets as we know them, financial assets are effectively just the sum of [assets’] future cash flows. And if you think inflation is structurally higher today and going forward, well, in today’s money those cash flows are worth less.
So what is the context that we currently sit at? Well today we have the US 10-year treasury is at 3%, and you have US inflation at 9%. So that negative 6% gap would be, if we are talking about negative real interest rates, the highest since the early eighties. So when we look historically in such an environment, gold has tended to outperform other asset classes.
Today it’s looking a little bit different in absolute terms; gold hasn’t outperformed as we would’ve expected it to, but again, it’s relative.
So if you think about what equity and bond markets have done recently, gold actually has served as a bit of a hedge in such a volatile environment.
FIFI PETERS: You hit a very valid point because some really smart listeners of the Market Update will point to the fact that gold hasn’t been shining in all of its glory lately, especially given all the worries that are out there. Do you understand the reason for that anomaly – why gold is not doing better in these times of adversity?
JITHEN PILLAY: It’s probably twofold. I think there’s a lot of debate currently about inflation. Is it structural or is it transitory? I think those people who are kind of in the transitory camp, perhaps there is a need to hedge inflation if it’s threatening to be here for a long time. So there isn’t a kind of massive … from financial assets into real assets.
I think we would take a slightly different view.
We think inflation is a bit more structural if you look at the drivers behind it. So, that being said, I think gold certainly has a role to play in a portfolio as a hedge against inflation.
I think the second part is if you think again in relative terms. So in absolute terms gold has been roughly flat over the last few years, but actually if you think about what markets have done in recent times, US and European markets haven’t been flat. So in that context I know it’s difficult to think you are looking for absolute protection but, if you think in relative terms, your goal actually has outperformed.
FIFI PETERS: All right. So it has [shone] by not registering the same level of losses that other markets have. In fact, by doing nothing, put simply. So if we’re going by your view as Allan Gray – that inflation is essentially here to stay for a lot longer than we thought – how then can investors get exposure to gold in their portfolios? I imagine it’s beyond buying the physical bar.
JITHEN PILLAY: Correct. There are two effective ways to get exposure to gold. The one, which you mentioned, is the metal and there are various aspects by which we can do that. We can hold gold ETFs, exchange-traded funds, we can hold Krugerrands or, if you really want, you can hold gold locked in a vault somewhere.
You would own the metal – or kind of exposure to the metal – if you’re looking to add portfolio stability. We look at portfolio stability because, if you look over the very long term gold tends to be uncorrelated with equities. By that I mean [that], especially in times of panic and in times of selling, actually what you’ve seen historically is gold affording some level of protection.
So when we are looking to reduce portfolio volatility, the metal itself can be quite useful.
The second avenue to get exposure to gold is the gold miners themselves. The thing with the gold miners, though, is there is a leverage play on gold, so the swings up or down are much greater than the metal price itself. The thing with the miners, though, something we’re very careful about, is knowing when to sell them – because the gold miners tend to have very, very poor economics over the very long term.
The reason for that is because when things are good they can’t help themselves. By that I mean when prices are high, costs tend to follow. And then, secondly, when times are good, the gold companies often find reasons to do big, expensive mergers and acquisitions – which generally aren’t a very good idea.
FIFI PETERS: All right. What about digital gold? Phenomenal returns this year. Just kidding. In fact, you’re not allowed to invest in digital gold – that’s Bitcoin.
But Jithen, we’ll leave it there for now. Thanks so much for your time. Jithen Pillay is an investment analyst at Allan Gray, speaking to us on how to protect our portfolios from the cost-of-living crisis that is being fuelled by inflation. It seems that all that [glitters] is gold from a hedge-management perspective.