Gold ETFs set to benefit as ‘fear trade’ intensifies

Sep 20th, 2017 | By | Category: Commodities

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Gold ETFs look set to continue their recent bull run as, according to a report issued by the World Gold Council, the spot price of the precious metal is likely to be supported in the near term as growing uncertainty moves investors into safe-haven assets such as gold.

Gold ETFs set to benefit as 'fear trade' intensifies, reports World Gold Council

Gold ETFs set to benefit as ‘fear trade’ intensifies, reports World Gold Council

“I often refer to this as the ‘fear trade’,” writes Frank Holmes, CEO of US Global Investors and author of the report. “For centuries, investors and savers have depended on gold in times of economic and political strife, and its investment case right now is as compelling as it’s ever been.”

According to Holmes, tensions over North Korea, a weakening US dollar, political uncertainty in Washington, an over-valued US stock market, surging public and private debt and ultra-low interest rates around the world are all factors contributing to investors’ fears.

Holmes is most worried about debt levels. US government debt currently stands at around $20 trillion. “Worrying as this is, it doesn’t even take into account other forms of debt that I believe pose an even greater risk to capital markets,” said Holmes.

US household debt reached $12.7tn in the first quarter of 2017, which is $50 billion above the previous high set in 2008, according to the Federal Reserve Bank of New York.

“Even more worrisome is the fact that the number of delinquencies grew for the second straight quarter this year, as more income-strapped Americans binged on credit. As we all remember, this is what burst the housing bubble only ten years ago.”

Holmes points out that global debt has also risen to €217tn in Q1 2017, around 45% greater than it was at the start of the financial crisis. “Much of the leveraging occurred in emerging markets, specifically China, which is spending big on domestic and international infrastructure projects,” said Holmes. “Some are calling this mountain of debt ‘the mother of all bubbles’ or ‘the bubble of everything’.”

The next area of concern for Holmes is the US Federal Reserve. “It’s common knowledge that the Fed is actively in the process of gradually raising rates but a significant adjustment to its balance sheet is also coming sooner than many anticipated,” he said. “This poses a real risk for investors. According to financial management firm Incrementum Capital Partners, 16 out of 19 rate-hike cycles in the past 100 years ended in recession. The results were the same in five of the six times the Fed reduced its balance sheet, according to research firm MKM Partners.”

“Business cycles don’t just end accidentally,” says MKM’s chief economist Mike Darda. “They are killed by the Fed. If the Fed tightens enough to induce a recession, that’s the end of the business cycle.”

This is where gold’s historically low correlation with stocks would come in especially handy, argues Holmes. “Consider 2008, the height of the financial crisis: US stocks ended the year down more than 37%, while gold held its value, returning 3.4%.”

The current equity bull market, now in its eighth year, is one of the longest in US history. Despite this, gold has outperformed the S&P 500 in the 21st century, returning 86% more than the stock market since the beginning of 2000.

Gold, priced above $1,300 an ounce, is currently trading at levels not seen since September 2016. So far this year the precious metal has returned 14.6%.

Gold also looks cheap compared to the US stock market, which is highly overbought according to Holmes. “Major averages are regularly hitting all-time highs,” he said. “As such, the gold-to-S&P 500 ratio is near ten-year lows, meaning the yellow metal is extremely undervalued.”

Holmes recommends a 10% portfolio weight to gold, with 5% held in bullion and 5% in ETFs, mutual funds and gold stocks. Investors can, in fact, gain exposure to both physical bullion and gold stocks through ETFs.

ETF Securities offers the ETFS Physical Gold (LON: PHAU), which is designed to offer investors a simple way to access the returns of the gold market by owning and storing physical bullion. The fund was launched in April 2007 and currently has assets of $6.0bn, with a management expense ratio of 0.39%.

VanEck offers the VanEck Vectors Gold Miners UCITS ETF (LON: GDX), which gives investors exposure to the largest publicly traded companies that are primarily involved in the mining of gold and silver. The ETF was launched in March 2015 and has assets of $120 million, with a total expense ratio of 0.53%.

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