Start building the bunker
They keep telling us that the recession is over so maybe now’s the time to start worrying about inflation. That’s the view many wealthy investors are already taking, reasoning that a little bit of the yellow shiny stuff will provide some comfort as we start piling our cash into wheelbarrows to do the weekly groceries shop.
It is gold exchange traded commodities (ETCs) that have seen the biggest investor inflows this year so perhaps it’s not surprising that the gold price broke through $1,000 an ounce this week.
“Investors are concerned about sovereign risk, quantitative easing, government deficits and the outlook for the US dollar,” said Nicholas Brooks, head of research and investment strategy at ETF Securities, at a Dow Jones Indexes commodities briefing on Tuesday. “They are using gold as an insurance policy.”
Physically-backed gold ETC holdings are now 8 million ounces, up 33 percent versus end-2008 levels, he said. Gold inflows have been relatively steady, even when the price has corrected, with the biggest flows coming not when Lehman went bust, but when the scale of US quantitative easing and the fiscal cost of the financial bailout became apparent. This supports the view that gold is being used as a hedge against sovereign and inflation risk, Brooks said.
Billionaire hedge fund manager John Paulson has been building up a large exposure to gold this year, seemingly as part of an inflation hedge.
John Reade, head of markets strategy at UBS Investment Bank, also confirmed that UBS clients were showing an interest in assets that would provide inflation protection. “You don’t need high inflation for gold to perform well – you only need an increase in the number of people who expect inflation to rise.”
Over the last 30 years the returns from gold have been reasonable but not great, with high volatility, he said. But in an environment where the US dollar is weakening, the Fed Funds rate is rising and inflation is rising, gold can be expected to perform, with returns of over 40 percent per annum if CPI increases. This suggests that an investor’s tactical allocation to gold should rise in the coming months, Reade said.
He forecast an average gold price of $1,050 an ounce for 2010, pointing out that gold remains very lightly owned by most institutional investors. This was not consistent with inflationary or US dollar weakness scenarios, he said.