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No more safe havens

Andy Merricks says the very thing that made commodities safe in the past is what now makes them risky

Since the economic crisis of 2008, the growth in popularity of the multi-asset fund has generally been a good thing. Pre-crisis, most ‘cautious’ funds were simply a mix of equities and bonds, both of which fell through the floor simultaneously when disaster struck.

This, of course, ignores the earlier multi-asset funds that held property as well, but which had already fallen through the floor, having locked in their investors, 12 months before the 2008 crash.

The safe haven that became more investable due to the liquidity granted it by the exchange-traded fund structure was gold. In fact, other commodities could also be traded and held in certificated form, so true multi-asset funds widened their remit to include precious metals, oil, corn and so on. Others viewed multi-asset as an invitation to use long/short strategies, Forex and CFDs. So investors now have a welcome opportunity to diversify their holdings way beyond the equity/bond split of the past.

But it is important to know what your multi-asset provider is actually offering. Most importantly, do they have the scope to choose for themselves what they own, or do they have pre-determined asset allocation models that they have to adhere to?

There must be a risk that the very thing that made them a safer option in the past could now lead to unwelcome returns should they follow the pre-determined asset allocation route. If they have to hold a proportion in the commodity/gold sector, I think they face a strong headwind approaching.

If the hunt for income becomes a main driver this year, it will not be good news for either gold or other commodities. Commodities were in a sweet spot during the last decade, but this sweet spot may be turning a little sour. During their rise, the US dollar fell steadily, the world economy was strong and the Chinese demand surged while the supply side was patchy. I am not saying that China has stopped its development – far from it, but it remains about the only piece of the sweet spot in place. The others have reversed.

The only reason to own commodities is in anticipation of their price rising. As Warren Buffet said: “The value of commodities is determined by how much someone is willing to pay you in six months or a year.”

There is no income stream. This is why we expect a bear market to develop within the commodity sector. The search for income will drive investors towards far more attractive asset classes.

Again, gold pays no income. It has seen its price surge as it offered a safe haven from the storm that buffeted the equity and bond markets through the credit crunch and the eurozone crisis, but if money is beginning to creep out of the havens of cash and government bonds in search of a higher return, so it will from gold too.

If you study the rise in the gold price during the past decade, it is almost perfectly correlated with the rise of the ETF.

Before the ETF came along, if you wanted to own gold you had to go out of your way to find it, buy it, and more importantly, store it securely. The ETF changed that, as you were suddenly able to own physical gold in a certificated and extremely liquid form. This has undoubtedly led the price higher, as investors such as ourselves would have been unable to hold gold in investors’ portfolios simply because we could not trade it easily.

Herein lies the danger. If you can buy something easily, you can also sell it easily. If liquidity has added to the price in a rising market, it is also likely to magnify the losses in a falling market.

So choose your multi-asset provider with care because diversification does not necessarily equal lower risk.

Andy Merricks is head of investments at Skerritt Consultants

Adviser’s view

 Adrian Lowcock
Adrian Lowcock

We have already seen gold and commodity prices come off this recent high as equities rallied on back of Mario Draghi’s speech and unlimited quantitative easing in the US, so arguably we have seen the start of a bear market.

Gold certainly still has its defensive nature. It has rebounded quite strongly in the past couple of weeks following the Cyprus crisis, but not as strongly as one might have expected.

I agree that as a result of exchange-traded funds allowing investors access to physical gold there has been some changes to its behaviour, and it has become more sensitive to the risk on/ risk off trades we have been seeing in recent years.

However, it is what the large hedge funds decide to do that could determine the future price of gold. If they become big sellers, or even short gold, the price could plummet.

Unlimited QE in the US should drive down the dollar and drive up the price of risky assets. Commodities tend to be the last asset to benefit from this.

The search for income is an important theme for investors, although the recent rally has been led by banks and technology (in the UK).

But the key factor here is that the physical commodity does not generate an income, it is the businesses that do that. So to get an income you would need to be exposed to equities – hardly providing diversification.

I do not know if we are in the early stages of a bear market for gold and other commodities. However, if I was living in Cyprus or another debt-laden euro-currency state, I would seriously consider having some gold in my possession rather than in a bank.

Adrian Lowcock is senior investment manager at Hargreaves Lansdown


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