Precious metals appear to have regained their role as a source of portfolio insurance, showing strong performance when the rest of the market has fallen, with many names up more than 100 per cent, year-to-date. 
The key driver to precious metals regaining this mantle has been the synchronised global rate-cutting cycle as a response slowing global growth, due to increasing trade war concerns, which has acted to support gold on a relative value basis versus other currencies. Gold has long held this role but in more recent years had fallen out of favour with the emergence of cryptocurrencies.
The trade related deterioration in global growth expectations has remained the dominant influence on sector sentiment since then, as it has led to global rate cuts as nations’ monetary policy has seen yet further rate cuts to try and maintain positive global growth. We are now at an extreme with more than $16trn of negative yielding bonds worldwide. As a result, the gold price has continued to rise and at the time of writing it has moved above $1,500/oz, up over 17 per cent year-to-date. This has led to strong performance by the precious metal miners, especially amongst the smaller-midcap stocks that trade at a meaningful discount to their larger peers.
The declining rate outlook has been the main cause of improved sentiment in precious metals. President Donald Trump’s enforcement of sanctions and tariffs on countries which he wishes to excerpt leverage upon has elevated the risk for many to rely on the US dollar as a settlement mechanism. This has led to strong central bank buying as they look to diversify their currency reserves, with them adding 374 tonnes in the first half of 2019, the largest addition in the 19 years of the World Gold Councils data series. Exchange-traded funds have added 184 tonnes since the end of June, with holdings rising to just shy of 80 million ounces (2,500 tonnes), with this demand having an outsized impact on shorter-term moves, although Central Bank buying is preferred due to the stickier long-term nature of their purchases.
Uncertainty abounds
Other political flash points have also hardened investor risk aversion, notably recent Middle East unrest with the attack on a major Saudi oil facility. The chart below of global policy uncertainty, a useful proxy with which to visualise broader geopolitical risks, is tellingly at an all-time high and above levels seen during the Gulf War, 9/11 terrorist attack, the global financial crisis, Brexit and president Trump’s election. Reflecting this heightened uncertainty and near-term recessionary fears, governments and central banks have initiated further stimulus measures and a synchronised cycle of central bank loosening is currently underway. This has all helped demand for gold which, unlike the increasingly political dollar, has seen increased global appeal.
Global Policy Uncertainty Highest on Record
Source: Baker, Bloom & Davies – Global Economic Policy Uncertainty Index with Current Price GDP Weights
The risk of currency wars has also increased, which is supportive for Gold. Trump believes China are manipulating their currency lower, although they have actively been supporting it, yet stated as a thinly veiled threat that they are not holding it at any specific level. Perhaps the more important long effect of Trump’s weaponisation of the US dollar could contribute to its decline as the global reserve currency, with a more dominant combination of the euro and yuan a possible outcome. This would undoubtedly see the US dollar weaken, which would be supportive for US manufacturing, but would have negative effects on the cost of debt, potentially increasing the risk around their ability to service the debt.
We have previously talked about the risk of sovereign debt levels, noting this could be a catalyst for making this a nearer-term risk with material contagion implications. Again, this is not out base case assumption, but a tail risk we should be aware of.
We believe precious metal miners provide the best way to gain exposure to these drivers we have discussed, especially some of the smaller capitalised names that trade at a meaningful discount to their larger peers. The miners are naturally operationally geared to the gold price, where a 10 per cent move in the gold price can lift earnings 20-30 per cent or more. The last few years has also seen a pullback in spending on exploration and the development of new projects, which has left many of the larger gold miners with declining grades and reserves, suggesting they may look to acquisitions to offset this. Perhaps most importantly, the attractive valuations of many of the stocks means this is a sector that can still perform well without the demise of everything else in your portfolio.
Rob Crayford is portfolio manager at New City Investment Managers. All views are his own and should not be taken as investment advice.