Gold or gold miners?

Gold has glittered amid 2024’s clouded outlook, taking first place among major assets as at the end of July.[1] We can point to several factors that have supported the rally.

First, those clouds: with more than two-fifths of humanity going to the polls, uncertainty was always going to be a feature of 2024, and unexpected twists in India, France and most recently the US have only confirmed the need for constant reassessment of political risk. This is in addition to ongoing conflict in Ukraine and Gaza, underscoring how quickly uneasy peace can turn into outright hostilities.

Continued central bank buying has also supported gold prices, as has consumer demand from Asian investors, who are increasingly accessing the metal through ETFs, as well as physical holdings.[2]

Finally, expectations of rate cuts in the US, potentially leading to a weaker dollar, have provided support for the gold price over the year. The recent increase in market volatility has further supported the metal’s price.

Whether gold can sustain the year-to-date rally remains to be seen. Although we believe a rate cut in the US in the near future seems more likely now following recent market volatility, weaker central bank demand given their price sensitivity and long investment horizons and profit-taking from Asian investors could still spoil the party.  

Nonetheless, the recent spell of strong gold performance raises an important question: when might investors consider allocating to gold directly, and when might a position in gold-mining equities be more appropriate?

The case for gold: An insurance policy

For many investors, the underlying appeal of gold is its permanence in a changing world. Since Egyptian times the metal has been prized, and it remains a universally recognised store of value.

A related argument is that gold acts as an inflation hedge. As a real asset, its value increases with prices, although, as we’ve shown previously, broad commodities have historically provided a more direct and effective way of hedging the risks posed by inflation.

Over the past decade, broad commodities have consistently exhibited a higher positive correlation to inflation expectations, indicating they have more consistently reacted to periods of rising inflation with positive performance.[3] Nonetheless, we believe gold can fulfil a useful function within a multi-asset portfolio. With drivers that impact returns in a fundamentally different way than equity markets, gold can provide diversification*.

Gold might best be understood as a kind of insurance policy that can potentially pay off in extreme market scenarios.

Historically, when equity returns have fallen below 5%, gold has represented a small but important store of value that could provide reassurance at times of heightened market stress.

The case for gold miners: A play on price expectations

The historical return of gold-mining equities is unsurprisingly tied to the price of gold, as the revenues of these companies are directly affected by changes in the gold price.

However, returns are also influenced by idiosyncratic factors. While investors might look to mitigate some of these uncertainties by excluding companies whose operations are exclusively exploratory, making their revenues dependent upon striking gold, some equity risk factors remain.

Gold-mining equities can therefore be understood as an operationally geared play on the price of gold, with an additional equity risk premium.

The utility of this exposure is as a pragmatic way of gaining exposure to rises in the price of gold, with the additional benefits of potentially straightforward liquidity, none of the storage or logistical costs associated with gold, and potential income from dividend payments.

In summary, if an investor wants to add a form of insurance to a diversified* portfolio, gold may serve this purpose. Gold-mining equities, meanwhile, have historically provided a leveraged way of gaining exposure to the gold price.

* It should be noted that diversification is no guarantee against a loss in a declining market.

[1] Source: LGIM, Bloomberg

[2] Source: https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q1-2024

[3] Source: See data in the first chart of our blog: https://blog.lgim.com/categories/investment-strategy/gold-or-broad-commodity-exposure-which-is-the-better-diversifier/