With UK inflation reaching a 30-year high of 5.5% in January, investors may start to consider if now is the time to put money into the safe haven of gold.
In the past, the precious metal has held its value in times of high inflation and it has been used by investors to shield their portfolios against weakening currencies.
Though inflation is expected to stay on the rise for most of this year, a number of anticipated interest rate hikes by central banks could bring the cost of living back down and with it the demand for gold.
Indeed, higher rates mean investors can get better returns from income assets, increasing the opportunity cost of owning gold. However, as a real asset, the price should rise with inflation. This dichotomy presents an issue for investors.
George Cheveley, manager of Ninety-One’s Global Gold fund said: “Inflationary environments have historically been good for gold but I think to focus on high inflation being good for gold and low inflation being bad for gold is too simplistic.
“I think at its core, gold is a hedge against financial uncertainty and when inflation is running high or inflation is very low the markets are very uncertain because they don’t know how the central banks are going to react to that.”
He noted that rather than weakening gold valuations, interest rates could in fact increase demand for the precious metal as it adds to the unpredictability of the current economic outlook.
A recent study by the World Gold Council highlighted that the value of gold typically climbs upward after the first announcement of increased rates by central banks.
This is exemplified by the price of the Global Gold fund over the past few months, with the portfolio increasing 15.9% since Fed chair, Jerome Powell announced plans to bring up rates at the last meeting in January.
Total return of fund over past six months
Source: FE Analytics
Cheveley added: “If the Fed raises rates and inflation moderates, markets are clearly going to be pretty happy with that result – that would probably have a negative result for gold because the rest of your portfolio should be doing quite well.
“But any errors, hiccups or mistakes is probably going to be good for gold.”
If rates are bought up rapidly, it could put too much pressure on business too quickly and create a whole new set of problems – something that numerous experts such as Ben Finnis, account manager at Greentarget, have suggested could happen as early as March, if the Fed raises interest rates 50 basis points in March, double the initial forecast.
Robert Crayfourd, portfolio manager at New City Investment Managers, said: “The potential for policy error feels much greater as the market is weaned off 14 years of cheap financing. It is true rates are going up, but realistically how high can they go before serious pain is felt? Arguably inflation may run much hotter than rates can offset.”
Alarm bells were also rung by Ned Naylor-Leyland, head of strategy in Jupiter’s gold and silver team who also said new monetary policy movements will only add to uncertainty, stating: “While the US Federal Reserve continues to threaten to ‘normalise’ rates, it does seem improbable that it can do so without risking market stability.
“However, if the market wakes up to the fact inflation is unlikely to go away any time soon, or that rates cannot be raised to the extent expected, we would expect to see a big rally for gold.”
On the contrary, David Coombs, head of multi-asset management at Rathbone said that increased interest rates will mean higher returns for investors on other assets, dissipating the appeal for gold which pays no dividend.
He added that gold is only a hedge against stagflation (high inflation and low growth) and any speculation about gold now is driven by sentiment rather than facts.
Coombs said: “This is the problem with gold. It’s so driven by momentum, which you can’t predict. I don’t like investments that are so reliant on momentum because if you’re on the wrong side it can be incredibly painful.
“As a multi-asset manager, I never want an asset in a portfolio that’s going to have such an impact on returns that I can’t predict. It’s dangerous frankly.”
Despite this, Coombs added a small position to gold in his Defensive Growth and Total Return funds as valuations could increase massively if tensions in Ukraine escalate into conflict.
“They’re just a short-term, tactical position for those two very low-risk funds. I have not bought it for my other funds because, strategically, now is not the time to be buying gold.
“I loathe buying gold to be honest, so buying it this morning for the lower-risk funds goes against my instincts.”
However, his main defensive positions are in US index linked bonds, which he said had “much better correlation with inflation than gold” and is “one of the best investments we have”.
He also has put options against markets, which should work if investors’ panic over the high rate of inflation and sell-out of equities.