The Next Gold Rush?

Transcript

Oscar Pulido: Welcome to The Bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

As we approach the midway point of 2023, the economy has had a turbulent ride thus far. This year, we've seen bank failures across the globe, a debt ceiling showdown in the US, high inflation and central banks raising interest rates to their highest rates in over a decade.

The typical 60:40 portfolio needed an overhaul after a rocky 2022, and investors are looking for a new balance. But during that reassessment, one asset class seems to be having a standout moment among investors. That asset class is gold. In this episode, we will take a look into the history of this commodity and what investors should consider when allocating to gold in their portfolios.

I'm pleased to welcome back Gargi Pal Chaudhuri, Head of iShare's Investment Strategy, to help us take another look at why gold is having its moment to shine. Gargi, welcome to The Bid.

Gargi Pal Chaudhuri: Oscar, it's wonderful to be here.

Oscar Pulido: Gargi, you have a special seat, on The Bid podcast. You're a frequent guest. And today we're talking about gold, which is having a bit of a moment, and I think when a lot of people think about gold, they think about the gold rush of the 1800s or maybe a piece of jewelry, or maybe the color of the sky in New York in recent periods. But we're actually talking about gold as an investment. So, tell us a little bit about the history of gold as an investment in a portfolio.

Gargi Pal Chaudhuri: So, you ask an important question around the history of gold and thinking back, 2-3 thousand years ago, gold was still very much a medium of exchange.

It was a store of value and artifact of beauty. I think more recently, if you look back to about 700 BC, that's when we were really thinking about gold as a medium of exchange, a medium of payment. If you think about what happened in the 1790s with the Mint And Coinage Act US Congress passed that act putting a fixed price on gold with parity to the dollar.

And more recently, in 1971 when we broke the gold connection with the dollar, I think all of this was the period where, gold came to the forefront as an investment as that second thing that we were talking about, which is around the medium of exchange and a store of value.

And I think it's important to think about why we as investors gravitate towards gold, and I'm sure we're going to talk more about it, but why is it gold? Why isn't it something else? When we are talking about precious commodities, and I'm Indian, as you can hear from the voice.

And obviously historically my family, has invested in gold. But why? And if you think about the periodic table and you look at all the elements and you take out the ones that are reactive to air or react with water or rust too easily, you're left with very few that can actually stand the test of time, that can be stored without getting rusted, that are ductile and malleable.

That is why it has held its value, held its status as something that can be a source of investment and also be all of those other things like a medium of exchange and of course, artifact of beauty.

Oscar Pulido: So, you took us back to 700 BC, so you went way back in the history books to start to tell us a little bit about gold as an investment, but why is it having a moment right now if it's been around for so long? What is it about this particular period that is bringing it back into the spotlight?

Gargi Pal Chaudhuri: A few things. So, number one, there is a lot of concern around economic growth, and historically, we have found when there are periods of concern around the future of global growth, investors have turned to assets like gold, which are likely to be a good diversifier to traditional investments such as equities, such as bonds. So, number one, there is some concern right now around the growth dynamic globally of the US. So that's one reason. Number two, I think geopolitical fragmentation, geopolitical risks, especially when you think back to just last year with the war in Europe, with Russia-Ukraine, that led to a lot of angst. Again, if we thought about what were some of the concerns you had for 2021, none of us put war in the forefront in 2021, for 2022. So, I do think this geopolitical risk that arose and actually frankly concerns around more geopolitical risks that might be abound is another reason that investors are thinking about gold as an alternative.

Another reason, and I think this is a very interesting and important one, is the path of interest rates and the path of the US dollar. And we talk about the path of interest rates, and particularly it's the path of real interest rates, so inflation-adjusted interest rates. Remembering that while gold bangles are beautiful, and while gold can be stored in a vault for centuries, it still doesn't have a yield. So, when you buy a bond, you have an income associated with it, you have a coupon associated with it. When you buy a stock, you might earn some dividends associated with it, gold does not have that. It's a non-yielding asset. So, in a world if interest rates are moving higher, you can gravitate towards the bond markets to earn that higher interest rates. You might not be as attracted to gold.

But in a world where you expect interest rates to move lower or remain stable, if you expect real interest rates, so that inflation-adjusted interest rates to move lower, I think investors could find gold more attractive in those moments and I certainly think that's happening right now.

And then another one, we talked about the dollar, but I do think historically the dollar and the gold has had a negative correlation. So again, if your expectations are for the dollar to decline or even just not to increase anymore, that could be another powerful dynamic for adding gold to a portfolio.

But for all of the things that I mentioned, I think two that are probably in the forefront of investors' minds right now, are number one, this diversification away from the dollar, and we've seen many central banks, especially in the emerging markets, we've seen central banks such as China, India, Russia, that have been adding to their gold reserves to diversify away from the dollar. So that is something that's happening. It's been happening for a few years now, but certainly has been pretty profound in the last couple of months. And then the second one is this fear of a geopolitical event or a global growth slowdown that is driving this current moment and this current price action.

Oscar Pulido: So, you mentioned a number of things that impact the price of gold. But maybe just to go back to interest rates for a quick second because it feels like that's always something that we're talking about, especially when we have you on The Bid, which is on interest rates, if they're high, that all else equal doesn't make gold that appealing. But you're saying that it's not just the level of interest rates, but what they look like adjusted for inflation, and if those are headed lower, then that might provide a little bit of demand for gold in the market.

Gargi Pal Chaudhuri: So, it's a very good clarification, Oscar. We have to remember that markets are forward-looking, so it is what investors expect interest rates to do. So, if I own a real rate, so if I own an inflation-linked bond, for example, and I expect that real interest rate that I'm earning by owning that bond to go lower in the next six months or next year. Those are the two options, you own the bond that real interest rates that you're earning right now, it could go lower, or you could own that, and you expect that real interest rate on that inflation-linked bond could go higher.

So, in each of those scenarios, you are still earning a coupon on your inflation-linked bond. When your expectations are that real interest rates can either remain here or actually real interest rates are so low, and remember in the US that real interest rates were zero or negative for a long period of time, then you might think that you could own a non-yielding asset, which might give you a better outcome.

But if real interest rates are, you hold them, you expect them to remain pretty steady and you don't expect them to go lower in the near term, that's when you might want to gravitate towards gold. So, it's that relationship between real interest rates falling, in a falling real rate environment, you might want to gravitate towards gold, as opposed to in a rising real rate environment, where you might want to think about waiting to buy the real rates. Does that make sense?

Oscar Pulido: It does make sense. And I think another reason that investors look at gold is the belief that it's a hedge against inflation. Is that a correct assumption for investors to make?

Gargi Pal Chaudhuri: Yeah, a lot of times, I have clients that talk to me about inflation and they're looking for that ultimate inflation hedge and investors turn to gold.

Historically, if you look at price performance, there was one period of time in the 70s, very, specifically in the early 70s, where inflation, as we know, was in the double digits and when gold was a hedge. Outside of that though, no other period of high or very high inflation has actually resulted in gold being a good hedge.

So, outside of that very early 1971-1974 period, we haven't found gold to be a good inflation hedge. What it has been is a good geopolitical hedge. What it has been is not so much an inflation hedge, but a hedge where, more of a stagflation hedge actually, where again, if you expect real interest rates to go lower, which you would in a stagflationary environment, that's when it has actually worked as a better hedge.

So, I think it's a little bit of a misconception. And when you look at the performance of gold, it's been more mixed in inflationary or very high inflationary periods, outside of that one time that I mentioned, but when we expect real rates to move lower - and by the way right now, I do expect real rates will stay at current levels for some time and then eventually by the end of this year or next year, start moving lower - I think that could be one catalyst for gold to remain in the forefront of investors' minds.

Oscar Pulido: You also mentioned the periodic table, I must admit I pulled it up, a couple days ago, but partly in anticipation that you and I would be speaking, and actually, do you remember the symbol for gold on the periodic table.

Gargi Pal Chaudhuri: Come on! Au!

Oscar Pulido: Okay. Okay I remembered it too, but I needed to look at the periodic table, and you touched on that there are other metals that have similar characteristics, there's not many, but there's things like silver, platinum, palladium --

Gargi Pal Chaudhuri: Rhodium, palladium,

Oscar Pulido: Very good, so now, why are those not benefiting from this moment that gold is having? Or are they?

Gargi Pal Chaudhuri: Historically gold has been this really respected metal, right? I would classify gold and silver in the same bucket. Obviously silver not as much as gold. Rhodium and palladium were discovered much later, centuries later, we weren't reading about them in the time of the Egyptians and Bhagavad Gita and the Iliad and Odyssey, which all mentioned gold actually. So, they weren't around because they just weren't discovered. Platinum has a very high melting point, which again, you couldn't use that, especially in the olden days, you couldn't use that to build gold blocks or gold nuggets, et cetera. You couldn't use that melted down to create jewelry, now you can because modern technology - high-temperature furnace - but you couldn't back in the day.

So today silver certainly can have its moment, but this risk of hedge characteristic, so all the things that I talked about earlier when it pertains to geopolitical risk that certainly resides more with gold. And that's because gold has, historically, we went back and talked about the 700 BC, the form of payment, the 1792 Coinage Act, if you look forward 1934 Act, historically there has been a lot of correlation of gold as currency, gold as method of payment. Until 1971 you had to have your currency backed by gold, and then of course, in 1971 that was dismissed. But silver and platinum never had that. So now, even though we don't live in a world when any currency globally is backed by gold anymore, those other elements just don't have that same cash to them, if you will.

I'll also add that when we think about silver or when we think about any other precious metals, we always think about what are the users of it. So, silver does have many other users, obviously, in addition to being used for jewelry, you can use it for other purposes which gold can't be. So, I, I think depending on what you are looking for as an investor, silver can be a very good addition to your portfolio, but it might not have the same risk of geopolitical risk hedge, diversifier for your US dollar reserve that gold does.

Oscar Pulido: Essentially gold just has a longer history and sort of unique aspects to its story of why it serves as an investment in a portfolio. And I think for much of that history, only until maybe recently, buying gold was a clunky exercise, literally buying gold bars, which are heavy, and you've stored them somewhere, in a personal safe. But that's changed dramatically over the last 15 or 20 years, right? So maybe talk a little bit about how investing in gold has modernized.

Gargi Pal Chaudhuri: So, to your point, you could invest in gold as a form of jewelry, but if you invested in gold bar form then there was the cost of storage, not only is it finding a place to store but the cost of that storage, not everybody has the capability of renting out space in a huge vault to store their gold bars. Or even if they do, I think that that's an expensive proposition. I think what we have seen in modern days, today if you're an investor looking to invest in gold, there are a few ways to do it.

Obviously, you can participate in the futures market, that's the right or the option to buy gold in the futures market - that's not actually gold. What many investors, especially those that are truly worried about a geopolitical risk event or a massive global growth shock, you actually want to see that asset that you own, and I think the rise of gold ETFs where when you buy that ETF you know that your ETF is backed by gold, which is in a vault in New York or London.

That has risen in the past few decades and that has given everyone, you don't have to be a rich billionaire with a home in Switzerland and a vault to have access to storing gold. You can buy an ETF that gives you access to gold and do it in a very liquid and very efficient manner.

Oscar Pulido: I'm laughing a bit because I think about some of the recent episodes we've done, which hopefully you've listened to as well, and we talk about things like artificial intelligence, we've talked about digitization, and here we are talking about gold, which feels like a bit of a relic in investment market. So how is it that gold has endured during this digital age?

Gargi Pal Chaudhuri: Sure. the risk of sounding like a relic, which I don't want to, I will say that gold has survived because it can be a diversifier in your portfolio. It gives you that ballast, and it can be tactically an opportunity for investors looking to invest in the face of slowing a growth shock or geopolitical tensions. And that has held through many, many business cycles. I'll also say another big reason that we're talking about gold now is that historically for institutions looking to trade gold, it has been a pretty expensive venture. We talked about that, the storage costs and things like that.

ETFs now more recently have helped accomplish the digitization for gold for every type of investor. For more sophisticated clients using technology such as blockchain ledger, having a digital gold currency could help institutions trade even more efficiently.

So, we have alleviated some of the issues that may have existed a few decades ago with digitization. And the main reason that we are still talking about gold is some of the drivers of gold that existed a hundred years ago. And what we talked about when we started the show in terms of holding its value, being a medium of exchange and being an artifact of beauty. Many of those things still hold, and that's why we are here talking about it. But the good news is it has entered the digitized age with ETFs, allowing every type of investor to have gold-backed ETFs in their portfolio.

Oscar Pulido: Gargi, you've given us a great history lesson. You also wore a piece of gold jewelry today that I noticed, and I think there's a little bit of a story behind it.

Gargi Pal Chaudhuri: I did. So, I got married 15 years ago, and as I mentioned, I'm Indian, so for many of you who don't know this, Indians are actually the largest buyers of gold for wedding jewelry purposes. And I wore my wedding jewelry for this podcast to bring home that point. And there is such a thing as wedding season demand. So, every year in September, August or September, October, you'll hear people in the western world talk about demand for gold coming from Indian wedding season. And it's so exciting whenever I hear someone random talking about it! And based on what I'm wearing, in my hands right now, it is factually correct. Lot of Indian wedding gold demand.

Oscar Pulido: Well, thank you for bringing that special token to today's podcast. And thank you again for joining us on The Bid.

Gargi Pal Chaudhuri: Thank you for having me.

Oscar Pulido: Thanks for listening to this episode of the Bid.

This post originally appeared on BlackRock.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.