Asset Allocation Gold rush or fool’s gold? Three views on surging prices

With gold prices rising to record highs over the past three years, investors have increasingly turned their attention to this ancient store of wealth. What is driving the rapid increases, especially at a time when stocks and bonds have also generally done well?

The war in Iran halted gold’s rise for a time, as investors worried that higher oil prices might drive up inflation and thus lead to higher interest rates. Gold and interest rates have historically moved in opposite directions. But with the recent cease-fire agreement, volatile gold prices have stabilised in the range of $4,600 to $4,700 an ounce. While that is below the record high around $5,300 in January, it is still far above where it was when this remarkable rally began in early 2022 — when gold was trading below $1,800.

Where the price goes from here is a subject of vigorous debate. Was January the peak? Or does it have more room to run? And, regardless of its short-term direction, what role should gold play in a long-term investment portfolio? With those questions in mind, three Capital Group portfolio managers offer their views.

Gold prices are likely headed higher

Paul Benjamin, balanced portfolio manager

My outlook for gold prices is likely upward, but the magnitude will be determined by the level of real interest rates and real inflation-adjusted return from stocks and bonds. If you were to use a constant basket to define inflation, and you looked at real interest rates minus inflation, you would see that real rates have been very low since the global financial crisis. Gold tends to do well in those periods.

In addition, we had the freezing of Russian Treasury reserves in 2022, which caused central bank buying from non-Western central banks to accelerate dramatically. And then, interestingly, late last year we started seeing lots of news stories about the “debasement trade.” When people refer to the debasement trade, they are talking about fiscal concerns in many Western countries, including a lack of central bank independence and the risk that governments may need to inflate away their debt. I'd say those are the major issues that line up, driving gold and helping it accelerate in recent years.

In my view, gold has an important role in a portfolio, particularly in a balanced fund. I view it as an important diversifier. At Capital Group, we don’t buy physical gold or gold ETFs. Instead, I prefer to invest in companies that create value and can do better than if you had just owned gold. They are known as gold streamers: companies like Wheaton Precious Metals, Royal Gold and Franco Nevada. They are not miners. They are effectively finance companies. They make loans to copper miners or gold miners, and the loans are paid back in gold. All three companies have compounded their earnings per share 600 to 900 basis points a year faster than the increase in gold prices. And so they have done exactly what you would want. They have provided the traditional gold hedge while also contributing substantially to growth of capital.

Central banks have been the key to rising prices

Lisa Thompson, equity portfolio manager

Central banks are what I call price-insensitive buyers. They are not investing in gold to beat an index. They have an entirely different objective. They are trying to diversify their reserve base. They tend to be focused on risk and liquidity. When they adjust their asset allocation strategy, they do not care about the price. In my view, that has been the primary driver of gold prices over the past three years. It started with Russia and has extended to many other emerging markets, China being a notable example. But even in markets like Poland, you are starting to see this desire to diversify into gold and away from the US dollar.

It is difficult to speculate on motives but, obviously, the world is changing. They might be worried about the stability of fiat currency, or that we are moving into a multipolar world, or lots of other geopolitical issues. They are not necessarily dumping US Treasuries, but with their incremental reserves, they clearly are diversifying. Some are being more aggressive, some less. That is a totally different demand driver than anything we’ve seen in the past 30 years.

I think it’s a very important change. Will it last forever? No, of course not. But for now, there is just a structural demand for gold — and that is supporting gold prices. Keep in mind, near term, gold can be very volatile. It can move up and down sharply on a day-to-day basis. But I think we are seeing a different set of price parameters now than we were a few years ago.

Don’t be surprised if gold disappoints

Rob Lovelace, equity portfolio manager

Over time, gold provides normative to no creation in value. It’s a commodity that is primarily a store of wealth. In recent years, the largest buyers of gold have been central banks. However, prior to this buying activity, central banks for many decades had been divesting gold because it's not a very useful asset. It doesn't pay interest. It doesn’t compound. In fact, physical gold essentially has a tax on it because you have to bury it in a secure place and hire guards to protect it. So it actually has a negative income, especially at scale.

A few years ago, central banks were more interested in owning interest-bearing instruments, and the US dollar was seen as safe and secure. As confidence in the dollar has waned over the past few years, central bank gold buying has increased. I would attribute much of the current run in gold prices to this asset allocation decision that many central banks — almost entirely outside the US — have made to hold fewer dollars and more gold. At a certain point, they will have all the gold they need. They will no longer be buyers. And since there is a constant stream of new gold coming into the market from gold mines, at a rate of about 1% or 2% a year, you need to have a consistent, incremental buyer or the price will go down.

I have never used physical gold as an asset in my personal allocation mix, and I rarely use the indirect path of owning gold stocks or other gold-related investments in my portfolio. That said, throughout history, gold has served an important role as a store of wealth, as a currency, and as a hedge against inflation. In my view, gold is an asset of last resort. In essence, if everything goes wrong, at least I have the gold.