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by  Jeffrey Schok, CFA Nov 27, 2020

We live in an era of historically low interest rates, and the likelihood that it will persist for a prolonged period confronts investors with a quandary: which asset classes offer a degree of protection if low rates remain a long-term feature of the investment landscape? Gold and gold equities, which tend to outperform when interest rates are low or falling, may provide part of the solution – particularly when investors are not being compensated for inflation. Moreover, the low correlation of gold-related assets to both bonds and stocks makes investments such as the actively managed RBC Global Precious Metals Fund an ideal diversifier for a balanced portfolio.

In this environment, shares of gold producers, developers and explorers are well positioned, and higher prices are not the only reason.

Today’s low interest rates are occurring against an economic backdrop significantly impacted by COVID-19, large government budget deficits and record global debt issuance, and at a time when central-bank asset purchases are turbocharging the money supply. The U.S., for example, is currently growing its money supply at an annualized rate of 23% while headline inflation is only 1.7%.1 In fact, real interest rates – the headline interest rate less the headline inflation rate – are negative all along the yield curve.2 The U.S. Federal Reserve (the “Fed”) has been clear that it’s willing to keep interest rates low indefinitely to ensure that inflation runs close to its 2% targeted level for some period of time.

While this environment is conducive to gold, it is important to remember that many factors influence the performance of gold, leading it to assume different roles at different times – as a currency, a safe haven, a store of value and a commodity. Even in an environment in which interest rates trend upward, gold can play a key role in portfolio diversification, especially as it relates to maximizing risk-adjusted returns over time. This diversification is particularly relevant in today’s environment, which is also characterized by the beginning of U.S.-dollar weakness and the rising potential for unanticipated inflation. We note that the two major gold bull markets since gold’s convertibility to the U.S. dollar ended in 1971 have lasted about a decade, meaning today’s gold investors can take advantage of what may be the next long-term bull market. What’s more, those two gold bull markets coincided with a declining U.S. dollar, and we are only seven months into a potential new bear market in the greenback.

The now universal pattern of central bankers responding to economic crises3 with massive monetary stimulus has been highlighted by the current economic fallout from the COVID-19 pandemic. We have not seen these levels of monetary stimulus since just after World War II, and a bullish investment scenario for gold comparable with today’s has not prevailed since the aftermath of the 2008- 2009 financial crisis, when the price of gold denominated in U.S. dollars almost tripled* in just three years and gold equities rose more than four-fold.**

In this environment, shares of gold producers, developers and explorers are well-positioned, and higher prices are not the only reason: gold companies have spent the past five years fortifying their balance sheets and committing to a renewed focus on capital discipline, shareholder returns and environmental, social and governance (ESG) factors. These steps are in contrast to the “grow-at-all-cost” philosophy that ended in the industry-decimating 2011-2015 bear market.

Why invest in gold equities?

The prospect of a prolonged period of low real interest rates presents investors with a quandary, especially fixed-income investors. Pension funds, in particular, may have trouble meeting retiree obligations due to historically low interest rates, forcing them and other investors to consider raising their equity exposure and/or adding alternative assets to their allocation mix.

While gold equities have rallied strongly since the start of the year, valuations remain within acceptable and historical ranges, and are justified given strong fundamentals and the long duration of past gold bull markets. As well, gold stocks are attractively priced relative to the broader market with a forecast 1.4% dividend yield. RBC GAM research finds that absolute and risk-adjusted returns are both enhanced when a 5% allocation of the RBC Global Precious Metals Fund is added to a traditional balanced portfolio composed of 60% equities and 40% fixed income. Moreover, the addition of the RBC Precious Metals Fund produced superior risk-adjusted returns relative to both gold bullion and the S&P/TSX Composite Gold benchmark. With interest rates forecast to remain near zero for at least the next few years, there appears to be good reason for long-term investors to include gold and gold equities as part of their asset-allocation mix.

Read the full whitepaper, or learn more about the basics of gold investing.

Note: *Gold – October 24, 2008 – September 6, 2011.
**Philadelphia Stock Exchange Gold and Silver Index – October 28, 2008 – September 6, 2011.

1. Source: Russell Napier, July 13, 2020, the market NZZ. Central Banks have Become Irrelevant.
2. Wikipedia on the Fisher Effect: The Fisher Effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation. Fisher proposed an equation to derive real or nominal rates exactly as: 1 + i = ( 1 + r ) ( 1 + π ). Where i denotes the nominal interest rate, r denotes the real rate and π denotes the inflation rate
3. Wikipedia, Greenspan put. During Greenspan’s chairmanship, when a crisis arose and the stock market fell more than about 20%, the Fed would buy bonds essentially without limit at high prices, lowering the Fed Funds rate — sometimes to the point of making the real yield negative — and bailing out the holders of bad assets. The Fed added monetary liquidity and encouraged risk-taking in the financial markets to avert further deterioration.


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