Could gold become the new global reserve asset?
Gold and silver, together with precious metals and mining stocks in general, have put in a strong performance and the temptation for some may be to take profits – if not reduce holdings significantly – after the recent volatility. However, well-rehearsed and recent factors which have supported the gold price could be about to be reinforced by the rising possibility that gold will become the new reserve asset underpinning the world’s financial system. This has not yet become consensus but will be supportive of the price if it does. While considered money’s conscience by some, a golden age is upon us – something the share prices of mining companies are also finally beginning to acknowledge. In this context, volatility should be seen as an opportunity.
Tailwinds old and recent
My column ‘The case for precious metals’ (22 November 2024) explains why our portfolios continue to remain overweight physical gold and silver. We have added to positions since. Slow economic growth hindered by higher government spending, debt and taxes crowding out the wealth-producing private sector, allied to the prospect of more volatile and higher than expected inflation in the coming years, are supportive of prices. Indeed, stagflation has historically been a fertile backdrop for gold and precious metals generally and there is no reason to believe it is different this time.
Heightened short and longer-term geo-political tensions are adding to its lustre. Wars, instability in the Middle East, the questioning of the world’s global institutions, are some of the factors creating immediate uncertainties. China, Russia and others challenging the US’ hegemony is another. This is at a time inflation and money-printing have brought into question the credibility of many currencies in recent years. Meanwhile, the bond markets are getting increasingly nervous about the continued growth in government borrowing – unlike debt, the metal has no counterparty risk. As such, gold’s safe-haven status grows and grows.
And recent developments have added to the metal’s lustre. Concerns about the unpredictability of the US administration, attempts to undermine the independence of the Federal Reserve, evidence of judiciaries both sides of the pond being politically weaponised, mounting evidence of sluggish economic growth globally, reinforce the case. We are also reminded that, whereas central bank buying largely accounted for the rise in the price over recent years, recent ETF figures suggest investors (institutional and retail) have only just become net buyers for the first time since 2020. This may further help to give gold a second wind.
US economic policy
However, since my column in 2024 other, less known but important factors have also perhaps been driving the price. That column made passing reference to gold’s ascendency being assisted by a weakening US$ – the currency tending to be inversely related to the gold price. However, the political agenda since in the US has become clearer. There is in Washington an absolute priority to rebuild the US’ industrial base especially after certain events exposed the economy’s vulnerabilities. The correlation of this policy to the gold price is courtesy of the intent to ‘dethrone’ the dollar perhaps to the point of needing to find an alternative global reserve asset to underpin the world’s financial system.
The US administration has made it increasingly clear it wants to onshore manufacturing to help revitalise the economy and reduce unemployment in vast swathes of the country’s rust belt. It considers the dollar’s status as the world’s reserve currency to have been a burden. The continuing trade deficits needed to furnish the world with dollars has hollowed out its industrial base in favour of other countries, which have then used their trade surpluses to invest in the US’ ever-expanding financial markets and debt. Wall Street has benefitted but left many behind. The onshoring policy is a priority which runs deep within the US administration – well beyond President Trump and so could be ongoing for some time.
The urgency of this policy has been reinforced for many by the pandemic which revealed too many supply lines for essential goods were dependent on China, and more latterly by the invasion of Ukraine which is showing the US and NATO faring poorly in comparison to Russia when it comes to ramping up the war effort. The production of strategically important goods generally has become an urgent priority – hence the focus on rare earth minerals. This is why the administration’s manufacturing agenda involves tariffs, even if this increases inflation, and weakening the dollar, even if this questions the world’s dollar-based financial system. One should not underestimate their intent to prioritise Main Street over Wall Street.
The new global reserve asset?
The administration’s increasing resolve begs the question what could replace the US$ as the linchpin of the international financial system? An asset such as a currency is required to act as an anchor, a store of value as a global reserve, otherwise the system cannot function. At a time the credibility of currencies has declined, no alternatives seem credible. Those in Brussels suggest the euro, but the EU’s economic fundamentals are waning. In 1990, its 12 member states represented over 26% of the global economy – today its 27 members now account for just 16%. It is too early for the Chinese renminbi even if credibility concerns could be tamed. The Swiss franc is too small. No other currency could perform the role.
Yet an alternative asset needs to be found. Could the answer not lie with gold? Its proud track record of being a store of value is universally accepted – its credentials are unquestionable. It cannot default – JP Morgan once opined that gold is money and everything else is credit. It would also be acceptable to both the US and China as the asset is ‘neutral’, so there would be no political loss of face. Both countries have been wise enough to accumulate large amounts of it. A higher price suits both, but particularly the US given a substantial revaluation of its reserves would allow greater fiscal headroom. And this is before we consider whether gold is the better asset to back the rise of stablecoins.
While gold usually benefits when the tectonic plates are moving, if this involves it becoming the new reserve asset for the global financial system then its lustre will shine even more. Perhaps this is why central banks have been buying so much in recent years. We have been here before. Within living memory, gold used to represent most of their reserves. For various reasons, including the US abandoning the gold standard and the IMF discouraging members from pegging exchange rates to gold thereby ending its formal role as a reserve asset, central bank holdings fell significantly. Currencies benefitted, especially the dollar. Yet recent figures suggest gold now represents nearly a quarter of all central banks’ reserves, from single figures a decade ago, and has knocked the euro into third place.
Investment implications
Gold and precious metals generally should be seen in their usual role of market insurance – we’re content when it is not necessary, and relieved when it is. However, it should also be seen as an investment in its own right given its track record and prospects highlighted above. Yet, away from central banks, recent figures suggest the asset has still not entered the investment mainstream. According to Manulife, broader investor (institutional and retail) exposure to the gold sector remains at historically low levels, with physical gold ETF’s having a current value of $300bn, equivalent to just 0.1% of global assets. There is a long way to go before the consensus catches up.
Gold’s journey will be volatile, but then sadly so is today’s world. Given the medium to long-term tailwinds, volatility should be seen as a friend – particularly if underweight. Given there is no investment trust focused on any physical precious metal, holdings consist of Invesco Physical Gold ETF (SGLP) and iShares Physical Silver ETF (SSLN). As an aside, the sector would benefit from the launching of such an investment trust.
Meanwhile, there remains an opportunity regarding the precious metal mining companies which, despite their stirring, continue to look attractive if valuations and history are a guide. Many of the mining stocks are seeing inflationary pressures ease at a time they are generating record cashflow and profits. Sentiment has still some way to go to catch up with the fundamentals. In recent years we have been gradually increasing portfolio exposure as highlighted in previous columns, which has complemented existing exposure to commodities. Some holdings have done very well.
Golden Prospect Precious Metals (GPM) focusses on smaller companies and has doubled in price in recent months. It also promises subscription rights at 48p a share although the 1 in 5 ratio previously suggested may have to be modestly scaled back because of prospectus rules as to the amount raised. Despite the company’s recent run, the portfolios have maintained exposure.
Meanwhile, CQS Natural Resources Growth & Income (CYN) has an enviable track record and c.45% exposure to gold and silver as part of a broader exposure to smaller companies across the commodities spectrum – including a mid-teen weighting to uranium, which we also like. The company has recently introduced a new dividend policy equating to 8% of NAV. BlackRock World Mining Trust (BRWM) complements holdings in CYN given the stock tends to invest in larger, more conventional mining companies and therefore commodities more generally, although gold still represents around 30% of the portfolio. A yield exceeding 3% is also helpful.
Disclaimer: The information contained in this article does not constitute investment advice or a personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
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