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Gold is under-owned by investors… for now

Gold bars are displayed at Shinhan Bank
The price of gold has risen recently yet it remains under-owned by investors. (Source: Getty)

Gold remains extremely under-owned by investors despite having a solid track record as a currency of last resort in times of uncertainty, and despite the current global environment being arguably more uncertain than any point since the second world war.

Current gold ETF holdings as a percentage of global ETF assets are tiny. An ETF (short for exchange-traded fund) is a security that tracks an index.

However, Market complacency could bolster the case for gold and the positive investment cycle in the asset class potentially has many years to run.

What do we mean by under-owned?

As the chart below shows, in 2012 gold was relatively well-owned, with gold ETFs over 10% of all ETF assets (including equities, bonds, etc).

Since then ETFs have expanded across asset classes and we have seen strong bull markets in bonds and equities. At the same time, and partly as a result, gold ETF holdings have fallen from over 85 million ounces in 2012 to around 68 million ounces (in August). Gold ETFs as a percentage of all ETF assets are now closer to 2%.

For gold, in a world still awash in liquidity and with financial asset values very high, this is positive.

We are not suggesting that ETF holdings in gold are not increasing. We have already seen total ETF holdings of gold increase by 32% in 2016 and by a further 8% year-to-date 2017.

What we are saying is that around $15 trillion of liquidity has been injected into global financial markets from central banks since 2008. So, when investors start meaningfully allocating to gold again, gold ETF holdings have the potential to grow at significantly higher rates than we saw during the 2004 to 2012 period.

Gold equities

Now, if we look at gold equities, we see a similar picture (see chart 2). The current weighting of North American gold equities in the S&P 500 and Toronto's TSX has fallen to just 0.6% after reaching a peak of over 2% in 2012.

To put this low weighting in perspective, the entire North American (US & Canadian) gold producers have a combined market cap of less than $150bn.

This is tiny and highlights the scarcity value of gold equities if a bull market in gold gets going. Essentially, this extremely low weighting reflects investors’ current low positioning around gold and gold equities, as well as the very high valuations of other more mainstream sub-sectors.

This relatively low weighting surprises us given increasing geopolitical risk, increasing risk of inflation and therefore negative real rates. It is also surprising given that the majority of the companies we invest in have improving fundamentals and are trading at the lower end of their historical valuation range.

Relative to gold, we believe gold equities still look cheap and we would stress that our equity holdings are currently discounting gold prices of less than $1,200/oz, at a time when the actual gold price is $1,327 (as at 12 September).

Important Information: The views and opinions contained herein are those of Mark Lacey, Schorders' equity fund manager, and James Luke, Schroders' metals fund manager, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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