Fidelity Viewpoints — June 22, 2010
How to invest in this volatile asset.
Case for Gold
With turbulence in Europe shaking many investors’ faith in the markets, one asset class has actually increased its luster. As stocks around the world plummeted, gold recently made a new all-time high, as least in nominal terms, with the spot price surpassing $1,260 per ounce on June 18, 2010. The question now on investors’ minds: Can gold go even higher?
Despite some recent volatility, Joe Wickwire, the portfolio manager of Select Gold Portfolio (FSAGX) believes that gold is still in the middle innings of a secular (long-term) bull market. From Wickwire’s perspective, this asset class offers investors potential diversification benefits, as well as a way to help protect their portfolios against a possible loss in global purchasing power if dollar-denominated assets fall in value.
Viewpoints caught up with Wickwire recently. Find out why he remains bullish on the gold asset class and believes most investors should have some exposure.
Q: Gold has historically been quite volatile. Over the last nine years, there have been a number of sharp pullbacks in the spot price, each one threatening an end to the gold bull market. Nevertheless, the price of gold has recently once again made new highs. What’s your outlook for this asset class?
Wickwire: I think that the gold asset class remains in a secular bull market. From 1982 to 2000, we saw the greatest bull market for financial assets such as stocks, bonds, and currencies in history, and a corresponding secular bear market for hard assets including gold. Since the financial asset bull market ended in 2000 with the dot-com bust, we have been in a bull market for gold and other commodity investments as the reasons for the financial bull market reversed and a strong set of tailwinds for the commodities asset class emerged including globalization and reflationary monetary and fiscal policies.
This back and forth between the different asset classes is quite consistent with history. But while the financial asset bull market had an 18-year duration, we are only in the ninth year of absolute and relative outperformance for gold. What’s more, when adjusted for inflation, gold is still well below its historic real record price last seen in 1980. [Past performance is no guarantee of future results.]
Still, I believe that gold as an asset class is really underowned, underappreciated, and undervalued, and that the long-term fundamentals indicate that gold has room to rise, as long as the key drivers for its ascent continue to be in place.
Q: What do you think are the key factors driving the price of gold today?
Wickwire: In my opinion, there are really two price dynamics that drive the price of gold. The first is its traditional end market, which is jewelry demand. The other is gold’s investment appeal as a strategic reserve currency or store of value. It is the investment appeal of gold that has been its chief price determinant over the past nine years, and I believe it is likely to be the key driver in the foreseeable future.
Conceptually, investors might think of the investment demand for gold as providing its price ceiling, and jewelry demand its price floor. Regarding gold’s strategic investment appeal, the gold asset class (bullion and gold equities) has historically done very well in periods when many financial assets haven’t.
Q: Given that backdrop, would you elaborate on the fundamentals supporting higher gold prices?
Wickwire: I see three: 1) macroeconomic imbalances, 2) geopolitical tensions, and 3) a favorable supply-demand balance.
First, macroeconomic imbalances will most likely not get resolved unless China and other "peggers" (whose currencies are pegged to the dollar) allow their currencies to appreciate and be market-determined. If this happens, I believe the U.S. dollar would likely weaken and gold could continue to move higher.
Second, the world is rife with geopolitical tensions—ranging from the conflicts in Iraq, Afghanistan, Israel/Palestine, and North Korea, to the growing threat of protectionist trade policies. In times of global conflict, investors have historically demanded gold as a safe haven, as gold is the only commodity that is a currency, and it is the only currency that is not someone else’s liability.
As for supply and demand, there’s been a lot of spending on gold exploration over the last few years, but little has been found. As a result, world mine production has declined as the price of gold has risen. In addition, central bank selling has been relatively muted of late, while some central banks, namely Russia, China, and India have increased gold as a component of their foreign exchange reserves.
Investment demand for bullion has been strong in recent years, driven largely by the aforementioned drivers and investors’ concerns about protecting their global purchasing power. And I believe jewelry demand should remain strong as long as new emerging-market middle classes continue to be built in countries such as China and India where there is a strong affinity for and capacity to own gold.
Q: Over the last few years, gold has often displayed an inverse relationship with the U.S. dollar, moving higher in price as the dollar fell against other major world currencies. More recently, we’ve seen gold rally alongside the dollar. Why the shift?
Wickwire: It’s true that gold historically has had at times, a strong inverse correlation with the U.S. dollar. But, gold’s price recently has been rising in all currencies; so it’s more than just a “weak U.S. dollar” story. What’s more, the price of gold has historically had a positive relationship with the growth of overall global currency reserves, which have increased from roughly $2 trillion to over $8 trillion [U.S. dollars] over the last decade as almost every country around the world has had to pursue reflationary monetary and fiscal policies. The last point is that gold has historically risen in price when real interest rates (after inflation) were below 3%. Recently, real interest rates were actually below negative 2%.
Q: In your opinion, how should investors view investing in gold?
Wickwire: Gold and gold stocks can be used by investors to diversify their largely U.S. dollar-based portfolios into an asset class that has historically performed relatively well when the dollar and financial assets (such as stocks, bonds, and currencies) underperform. Because gold is imperfectly correlated to the U.S. dollar and other financial assets, investing in a gold fund offers the potential to help protect against a loss in global purchasing power.
When you think about your allocation to gold, I believe that it is useful to think of it like a financial asset insurance policy. When you buy insurance, you don’t necessarily want all of the events you’re insuring against to take place. That’s true here as well. We hope that a sustainable recovery is taking place, and that the markets, credit, economic imbalances, and investor confidence all get repaired. In addition, we hope that inflation doesn’t accelerate as a result of the worldwide stimulus being applied to various financial and credit problems. However, should some of the world’s issues not work out smoothly or favorably, maintaining a small allocation to gold in an overall diversified investment portfolio could potentially be beneficial.
Q: But isn’t gold an extremely volatile asset? How should investors take that into account?
Wickwire: The gold asset class is probably one of the most volatile asset classes in the investment universe. Due to this volatility, you really need to understand why you own it and how much you might need to own.
Since gold is not highly correlated with dollar-denominated assets, I think it remains a good diversifier for long-term investors who can stomach some short-term swings in price that could potentially be moderate or extreme. If you’re thinking of buying gold assets, you might want to keep them to a small percentage of your overall portfolio, and consider dollar-cost averaging into the space, over time. That way you would potentially be putting gold’s volatility to work for you.
Q: Have you favored holding physical gold itself or buying the stocks of gold mining companies?
Wickwire: I prefer the gold stocks. When gold prices are rising, the stocks of gold mining companies have typically outperformed gold itself. That’s because gold producers can provide operational and financial leverage in a rising gold price environment. Because many of the costs of producing gold are fixed, when producers’ top line revenues go up, earnings can go up even more. This is what we've seen over the last 10 years in a low inflation environment, as well as during the inflationary 1970s.
I like to say that as beautiful as a bar of gold is, it doesn't generate earnings or cash flow, it doesn't pay dividends as, and it can't find more of itself. Gold producers have that potential. What I look for are low-cost, high-grade gold producers who hold long-lived assets, operate in politically safe areas of the world, and trade at a significant discount to intrinsic value. Gold is an inefficient asset class, so I also think investors can benefit from having an experienced professional managing their gold allocation.
From Fidelity.com published on June 22, 2010
