Time to buy gold to hedge against ‘excessive’ market rally?

Investors have started to return to gold as a hedge against any potential disruption to the continued rally in world equity markets.

Gold has fallen significantly over the course of 2013, dropping from $1,675.35 an ounce at the start of the year to a low point of $1,200 towards the end of June. The price has recovered slightly since then to reach around $1,280 today.

ETF Securities head of research and investment strategy Nicholas Brooks says investor concern about “a potential excessive rally in cyclical assets”, as well as concern about the health of the eurozone, could see stronger flows return to the yellow metal.

According to FE Analytics, the S&P 500 has risen 28 per cent over the year to date. Over the past six months, the rally has been led by cyclical sectors such as industrials, information technology, materials and consumer discretionary. A similar trend can be seen in the FTSE All Share, which is up more than 19 per cent so far this year.

Brooks says: “With France’s credit rating cut to AA by S&P and the ECB having to deal with extremely low inflation and high unemployment, tail risks in Europe remain elevated, prompting investors to seek protection in gold.

“The extent of the recent rally in equity markets may also be starting to worry investors, causing some reallocations into gold as a hedge.”

Junior Gold fund manager Angelos Damaskos argues that the fundamentals supporting a higher gold price remain in place, highlighting that the US debt ceiling debate will return to haunt markets in 2014 while inflation remains persistently above economic growth rates.

Damaskos adds: “Geopolitical tensions seem to grow rather than recede, particularly in the Middle East and North Africa, the most prolific oil producers. In this environment, gold should still have a prominent place in every portfolio as a diversifier and insurance against the unexpected.”

Macroeconomic forecasting consultancy Capital Economics says the prospects for gold look better than for most industrial metals, despite the fact that likely rises in real yields will increase the opportunity cost of holding the metal.

Chief global economist Julian Jessop says: “As long as global monetary policy remains relatively accommodative, there should still be some upside for gold.

“We expect the price of gold to grind higher (back above $1,500 per ounce in 2015) due to resilient demand for safe havens and inflation hedges, as well as persistent interest from households and central banks in emerging economies.”

However, BlackRock chief investment strategist Russ Koesterich warns that gold investors may have to prepare for further down periods as the likely grows that real rates will rise.

“We believe the precious metal has a place in investors’ portfolios, but an environment of rising real rates tends to be a headwind for gold. Since late October, for example, real rates have climbed roughly 20 basis points, and at the same time, gold prices dropped approximately 4 per cent to 5 per cent,” he says.