Almost a quarter of world GDP lies in economies whose central banks now have negative interest rates of some form. This experimental policy – used variously to weaken strengthening currencies and attempt to stimulate growth – has its fans, but investors have not been among them.
“There’s a sense that central banks are running out of ways that they can stimulate the economy,” says Chris Beauchamp of IG. As Deloitte economist Ian Stewart, among others, has pointed out, while in theory negative rates should encourage banks to lend and consumers to spend, in practice, they could just prompt individuals and companies to hold physical cash instead. “Just imagine the boom in sales of safes,” said Stewart in a recent note, if retail banks across the Eurozone and Japan passed negative rates on to their customers.
But negative rates have also been cited as part of the explanation for one of the strongest investment trends this year: the rally in gold prices. The precious metal had at one point risen by about 20 per cent since the start of the year and is now sitting above $1,200 per troy ounce.
Haunted by past failures
Although the rally has been strong, gold prices remain low by the standards of just a few years ago. “Gold bulls are haunted by the lack of performance since the all-time high in September 2011 [when prices topped $1,920],” says Ross Norman of bullion firm Sharps Pixley. “It’s been a tremendous year-to-date, but confidence is still fragile despite phenomenal performance.”
The rise has also moderated since the dark days of February, when fears about the health of the banking system prompted reports of people queueing in the streets to buy gold. “Coin dealers in the UK and the States are advertising special discounts,” says Adrian Ash of gold and silver exchange BullionVault. “That would suggest that, with higher prices holding, they’re seeing an inflow of metal from existing customers seeking to sell.”
But Norman identifies a new trend that could be supportive of gold if concern about central bank interventionism is further heightened. “In the last few years, we saw the West falling out of love with gold, but the East falling in. This year, with economic risks getting a notch higher, we’re seeing phenomenal flows of physical buying in Germany, the renaissance of physical buying in the UK. We see central banks in Europe revisiting views about selling gold.” Physical buying refers to the purchase and storage of gold in coin or bar format, but investors can also get exposure through ETFs tracking the price of the metal or gold miners.
In Germany in particular, he says, there is deep concern about the route the European Central Bank is taking. “Not everyone is a Keynesian and believes the way to resolve economic crisis is to put more debt on debt.” Germans have a higher propensity to save but also a higher level of caution about economic experiments, given their history. A 2010 report by the Research Centre for Financial Services at the Steinbeis University, Berlin found that 26.2 per cent of Germans have some physical investment in gold coins or bars. World Gold Council figures show that annual German demand is averaging 100 tonnes per year, versus a pre-crisis average of 15 tonnes. And earlier this month, in a sign of institutional interest, reinsurer Munich Re announced that it is boosting its cash and gold reserves in the face of negative interest rates.
Time to buy?
Does this mean gold is a good buy? Not necessarily. Norman says gold has been overbought. “It’s got ahead of itself already. We expect price to retrace before moving higher over the long term.” Ash notes that retail buying doesn’t tend to be a driver of gold prices, and that this year’s rally has been more down to “managed money coming roaring back”. He highlights the SPDR Gold Shares ETF, which in terms of metal weight, has this year erased all of the losses it clocked up in 2013 and 2014.
Nutmeg, says its chief financial officer Shaun Port, will not be buying gold. “It doesn’t provide income. When you invest in gold, you also invest in the US dollar, because gold is always quoted in dollars. And sterling is at a 30-year low against the dollar.” He suggests long-dated government bonds are a better bet for a negative interest rate environment. More hawkish comments from the Fed in the last few weeks have led to the gold price falling back from recent highs.
But as Deutsche Bank has argued, given stresses in the global economy, there may be a case for buying gold tactically as an insurance policy. And as the precious metal tends to perform better when inflation is higher, any sign that central banks have lost control could be highly supportive. “The bottom line is that gold tends to do well when other assets do badly,” says Ash. “But it does best when people lose faith in central banks.”
This article appears in the March edition of City A.M.'s Money magazine, which will be distributed with the paper on Thursday 31st March.