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Gold Deserves Respect In Uncertain Times - Lombard Odier

Tom Burroughes, Group Editor, 30 July 2019

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The Geneva-based firm adds its voice to the argument about the role of gold in portfolios as a form of insurance against rough markets.

Lombard Odier has added its voice to the wealth management houses in favour of holding gold as a way to protect against geopolitical uncertainties and trends such as a weakening dollar.

A lack of credible safe-haven alternatives, low or even negative sovereign bond yields and global tensions mean that the yellow metal should be included in clients' portfolios, Stéphane Monier, CIO at Lombard Odier, said in a note.

“Gold’s traditional role in a portfolio has been as a hedge against inflation and equity market volatility, and as a diversification tool. This year, a combination of factors have driven gold to six-year highs. These include expectations of lower interest rates in the US, a weakening US dollar and rising geopolitical risk in the form of US-China trade, and tensions with Iran in the Gulf. In addition, uncertainties around the late economic cycle and widespread negative yields have all pushed investors to look for alternative havens," Monier said.

His comments are a reminder that gold, sometimes derided as an old-fashioned investment area, continues to draw support. A few weeks ago, Standard Chartered said there is a case for it in portfolios; Pictet, the Swiss private bank, has for example at times spoken in favour of gold. (Part of the controversy around gold is that it doesn't produce a yield - which is precisely why it is seen as a form of money.)

“It is worth reminding ourselves that gold trades for the most part on financial demand, rather than on fundamentals (physical market). A big driver of financial demand is fear in financial markets, which is why gold often acts as an effective hedge against volatility. And today, while the effectiveness of government bonds as a hedge decreases with the level of yields (the potential for lower yields is more limited when bonds are trading in negative territory), holding gold in multi-asset portfolios is necessary. In fact, the additional financial demand induced by the lack of safe-haven assets is likely to limit downside risk, and given the already exceptional length of the cycle, we can expect recession fears will periodically re-emerge," he continued.

Not for granted
Adding a cautionary note, Monier said that investors should not bank on the fact that gold and equities are negatively correlated, noting that gold volatility has often been similar to that of stocks.

"As such, adding gold to a multi-asset portfolio usually means adding to the overall portfolio risk, which is why it’s key that this allocation is tactically managed. In fact, there have been striking moments where gold did not protect portfolios against equity drawdowns, notably in the financial crisis in October 2008 where both gold and US equities dropped around 20 per cent (on global de-risking of portfolios and forced sales by funds stuck with their illiquid credit positions). Nevertheless, gold quickly attracted flows again and recovered losses, gaining almost 35 per cent when equity markets fell another 30 per cent," he said.

“Indeed, gold has always been thought of as the ultimate hedge against financial instability and any loss of confidence in financial and monetary institutions. Since the financial crisis, accommodative central bank monetary policies have bailed out the financial system with two negative consequences. First, they have exacerbated social inequalities by benefiting most those able to invest and take advantage of the lower cost of money and rising asset prices. That disparity, in turn, has led to an increase in populist politics, undermining political stability," Monier continued.
 
“Secondly, the global economy’s greater dependence on unconventional monetary policy and inflated central bank balance sheets threatens confidence in the financial system itself. If the next stage in monetary policy fails to improve economies sustainably, investors may turn away from cash and towards gold," he said.

“We believe the current environment justifies an allocation to gold in our client portfolios," he said.

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