Value makes a comeback. And why gold?
There was a distinct change in the flavour of the rally in markets this week: a rotation into value stocks.
We saw an improvement in sentiment due to several positive developments as economies begin to re-open.
This included progress in vaccine trials, signs the Australian economy is faring better than feared and renewed commitment globally by governments and monetary authorities to support economic activity, as economies transition during this period.
To date, the rally in the market has heavily favoured sectors seen as more resilient to current weak economic conditions such as Technology and Healthcare.
Improved sentiment this week saw the rally extend to the broader market – with a large rotation into value companies.
In Australia, this was evidenced by the stunning recovery of banks as well as a recovery in Real Estate, Energy, Media, Consumer Discretionary sectors.
Equally, investors rotated out of sectors they had sought refuge in, such as Healthcare and Consumer Staples.
Several of the “value” stocks in your portfolio benefited significantly from this rotation this week, particularly Southern Cross Media (+57%), Boral (+16%), and banks – ANZ (+19%), NAB (+17%).
Recent developments have bolstered optimism; however, continued fiscal and monetary support remains critical. We are encouraged as governments and central banks have continued to implement measures that are required to assist economies during this period of transition.
The market will likely remain cautious over the coming months, as the world balances a restart to economic activity and limiting the spread and reemergence of SARS-CoV-2.
We have aligned the portfolio towards a view that the measures put in place during this period, and a renewed willingness and appetite from government and central banks to stimulate activity, will be reflationary.
However, a portfolio is more than just a list of stocks.
Companies have different drivers, which benefit to differing degrees in differing economic conditions.
These drivers work together to provide diversified exposure.
Your portfolio’s exposure to gold an example of this.
We see exposure to gold as important, particularly in the current environment.
Your Australian Equities sub-portfolio holds exposure to the gold of approximately 5%, through Newcrest Mining and Aurelia Metals.
We see exposure to gold as serving two primary functions:
1. As a diversifier
Historically, gold prices have had a weak to negative correlation to other asset classes. This is as the price of gold has had very little to do with supply and demand of the business cycle. Therefore, over time, exposure to gold dampens the “swings” in portfolio value, particularly during volatile periods or periods of unanticipated change.
2. A hedge, or form of insurance
During times of heightened uncertainty, volatility or unanticipated change, investors have historically sought out gold as a place to store value. Exposure to gold helps diversify against broader risk: those which are known, not easily quantified or unknown/unknowable. These include risks around the global financial system and unanticipated changes in economic conditions.
Gold as an investment
Gold is not a traditional investment in that it does not generate cash flow.
However, the price of gold is not arbitrary and is driven by quantifiable factors.
The price of gold can be broadly valued based on three main drivers:
- Cost or benefit of holding: This is the opportunity cost or in some cases benefit from holding gold. This can be broadly represented by long term interest rates, in real terms (the interest you would have received if you had otherwise lent your money).
- Price: As determined by the amount of money in circulation. More money in circulation leading to a higher price of gold, as the amount of gold, remains relatively constant. “Price” can be broadly represented by the value of the US dollar.
- Safety: People are willing to pay higher prices for gold during periods of volatility or high uncertainty. This can be broadly represented by the volatility index (VIX).
Through this framework, we can see that there are multiple future economic scenarios where an exposure to gold may be favourable.
These include scenarios where there is:
- Higher than expected inflation: with inflation, the opportunity cost of holding gold in real terms is lower.
- Lower interest rates: as above, the opportunity cost of holding becomes lower.
- Heightened volatility: geopolitical risk, shocks or changes to the financial system lead to investors paying more for the safety of gold as a store of value.
- An increase in the amount of money that is circulating: for example, an increase in the supply of money as a result of unconventional monetary policy such as quantitative easing.
- A combination of these scenarios: for instance, high inflation but low rates.
We have seen elements of this recently - particularly through the extraordinary measures central banks have taken.
The current geopolitical and economic environment has increased the likelihood of many of these scenarios.
We, therefore, see exposure to gold as important, to create a better diversified and more resilient portfolio.
We have seen an improvement in sentiment this week, with a rotation into value stocks and parts of the market that had not fully participated in the broader rally.
Some uncertainty remains; however, we are encouraged by the strong measures government and central banks have taken during this period of transition.
Your portfolio is aligned towards a view that activity will be stimulated through these actions, however, it is positioned to perform under multiple future scenarios.
Gold is an important part of this, serving as a diversifier and form of insurance.