After a three-year slump, the price of gold has bounced back this year. For Q1 2016, gold recorded its largest quarterly increase (+16.4%) in almost 30 years. This positive performance continued into April, and gold extended its gain for the year to 21.7%, closing the month at $1,290.50/ounce. This rebound came on the heels of three consecutive annual losses for the commodity that saw its price retreat over 36.6%.
This year’s performance has recalled the halcyon days before the recent slump when gold prices enjoyed a 12-year run (2001–2012) of positive returns, for a total price appreciation of over 515%. Data compiled by Lipper indicates that the surge in the price of gold this year has had a positive impact on the performance of gold funds and consequent new money flowing into them. Advisers, however, may not want their clients to forget that gold as an investment has endured many losing years, if not decades.
Several factors aligned during Q1 2016 to create the perfect storm for an increase in gold prices. After an initial interest rate increase in Q4 2015, the Federal Reserve exercised caution and did not raise rates in Q1 2016 because of global growth concerns as well as the U.S. economy’s failure to reach the Fed’s target inflation rate. Lower interest rates are bullish for gold because it competes for investors’ money against yield-bearing assets (U.S. Treasurys). Yield-bearing assets fare better as interest rates rise. Negative interest rates, as currently seen in Europe and Japan, also benefit gold, since they remove one of the main negative talking points about the commodity: that it yields nothing.
Gold also took strength from Chinese demand and a lack of investor confidence in central banks. China had been buying gold to rebuild its reserves to back its currency (the yuan), and gold was also used as a hedge against central bankers’ being unable to unwind in an efficient manner all debt positions acquired through quantitative easing.
There still appears to be time to take advantage of the buying opportunity created by the surge in gold. The conditions are still ripe for gold to continue to rise in price. While the Fed has left the door open for a possible rate hike at its next meeting in mid-June, there is uncertainty whether it will actually occur because of the mixed economic data.
The safest way clients can take advantage of this resurgence, other than buying the actual commodity, is to gain exposure to gold through ETFs. Lipper puts these funds in Commodities Precious Metals Funds classification. They are designed for investment vehicles that primarily buy-and-sell commodity-linked, precious-metals derivatives or the actual physical commodity.
Narrowing the category to just those that focus on gold finds that year-to-date (through the end of April) the ETFs have seen positive net flows of $8.1 billion and an average return of 13.4%. From a performance and net inflows point of view, the results have been dominated by the two largest gold ETF products: SPDR Gold Shares (GLD, +$32.6 billion in assets under management) and iShares Gold Trust (IAU, +$7.4 billion aum). GLD, which accounts for over 78% of the gold ETF group’s total assets, has taken in $6.7 billion of net new money, or 82.7% of the total net inflows, for the year to date. IAU – the second largest ETF in the category – has had the second largest net inflows in the group at $1.2 billion. Both products are at the top of the list for performance; IAU has posted the highest return in the group at 21.0% and GLD placed second at 20.9%.
The ETFs mimic gold’s performance up or down. For 2013, 2014, and 2015 gold prices retreated 28.2%, 1.5%, and 10.4%, respectively. As a result gold, ETFs suffered net outflows for each of these years, with 2013 being the most severe with more than $28.6 billion of negative net flows. GLD saw $25.5 billion of net outflows for 2013. The gold ETF group recorded an annual loss on average for each of these three years, with 2013 (-29.1%) being the worst.
Funds that invest in the equities of companies involved in mining, exploration, and distribution of gold should also be considered. Lipper's classification for these funds, Precious Metals [PM] Equity Funds contains both mutual funds and ETFs while the CMP gold funds are only ETFs.
Lipper analysis indicates that the year-to-date returns for PM gold funds (+81.0% on average) are more extreme than CMP gold ETFs, but the net inflows (+$135 million) are more muted for the PM gold group. The most impressive year-to-date gains for the group all belong to ETF products; Global X Gold Explorers ETF (GLDX), iShares MSCI Global Gold Miners ETF (RING), and Market Vectors Junior Gold Miners ETF (GDXJ) have experienced increases of 120.9%, 103.5%, and 98.9%, respectively. From a flows standpoint the largest increases all come from mutual funds; Fidelity Select Gold Portfolio (FSAGX), First Eagle Gold Fund (SGGDX), and Tocqueville Gold Fund (TGLDX) have taken in $178 million, $50 million, and $25 million of net new money, respectively.
Similar to the CMP gold funds group, a correlation with the price of gold exists for PM gold funds when the price of gold drops. During the run of three consecutive annual losses for gold prices (2013–2015) the average return for PM gold funds also experienced three consecutive losses, with the largest (-50.4%) occurring the year the price of gold fell the most (2013).
However, this correlation breaks for the fund-flows data for the PM gold funds: despite the decrease in the price of gold for each of those three years, the group took in net new money during each of the years. PM gold funds had total net inflows of $2.2 billion for this three-year interval, with all the gains coming from two Market Vectors ETFs: Market Vectors Gold Miners ETF (GDX) and Market Vectors Junior Gold Miners ETF (GDXJ) grew their coffers by $2.9 billion and $1.4 billion net, respectively.
Another positive for the price of gold is that 2016 is a presidential election year. In previous election years, the Fed has been hesitant to make rate changes in the second half of the year in order to not unduly influence the election. Given these factors, it’s quite possible an interest rate hike will not be viable until the Fed’s December 2016 meeting, post-election.
With that being the case, gold prices would still have the majority of the year to appreciate unimpeded by competition from U.S. Treasurys, thereby making commodity gold ETFs and equity gold ETFs and mutual funds attractive investments.