Strategist explains his bullish outlook for the yellow metal in institutional portfolios
Canadian pension plans are facing a host of problems stemming, largely, from a huge cohort of retirees, a smaller cohort of contributing workers, elevated inflation, and the longest life expectancies in history. To manage those problems, pensions need to grow their assets. That’s how we got the maple eight model and the levels of sophisticated multi-asset management that the global pension industry practices.
Uncertainty abounds, however, and many of the alternative assets that drove growth for decades are lagging in a higher interest rate environment. Public equities were a major contributor to performance over the past 18 months, but that has been highly concentrated in a few mega-cap assets. Moreover, we are seeing the beginnings of a rotation in the market as those mega-caps pull back in favour of a broader set of value names.
As pension funds look at their asset allocation, there is one asset which may be worth consideration: gold. Gold has had a remarkable run since October of 2023, rising faster than the S&P 500. It has bucked expectations somewhat, rising along with US GDP growth and a bull market in equities. At the same time, gold is that traditional safe haven asset with a history of non-correlation to falling equity markets.
Joseph Cavatoni, market strategist for North America at the World Gold Council, shared a macro view of what’s driven gold prices recently. He explained some of the dynamics in the gold market and how institutions are accessing the yellow metal. He outlined, as well, the potential utility of gold for pension funds in an uncertain macro environment.
“If you understand the strategic and tactical drivers in gold, you can step back and say ‘if I feel good I’m going to spend’ that means buying markets as things go up, and gold correlates positives with equities to the upside,” Cavatoni says. “Where they differ is on the downside. Gold is not a risk asset, so it’s negatively correlated to equities on the downside.”
While gold lacks the cashflow associated with bonds or equities, Cavatoni emphasizes that gold does generate returns in price appreciation over the long-term and exists in a highly liquid market. That appreciation, Cavatoni says, comes down to a strategic and a tactical motivation for gold investors.
The tactical approach is what many investors associate with gold investments. It’s driven by momentum and opportunity cost, investors moving into a fast-moving trend, or using gold as a short-term hedge against volatility or the US dollar.
The strategic approach, Cavatoni says, is more driven by long-term appetites for gold, whether out of a positive economic outlook and the expectation that gold consumption will rise, or as a long-term way of offsetting portfolio risk.
That strategic approach is key to the recent run up in gold prices. So too is another core aspect of the gold market: its global nature. Cavatoni says that much of the price appreciation in gold has been driven by emerging market central banks and Asian investors. While US markets have done very well and US, Canadian, and European investors have added to their risk assets, Chinese markets have struggled — as have many other traditional emerging markets. In a rockier environment, investors in China and other emerging markets have allocated more heavily to gold.
The ongoing rotation away from concentrated equity names towards a broader range of equities in Western markets, Cavatoni notes, may add another tailwind for gold. The factors that play into this shift include concerns about underlying economic performance and the impact of high rates on corporate earnings. Add to that a US election year that should add volatility to markets. That rockier outlook may motivate Western investors to look more closely at gold as a defensive asset. Cavatoni already sees this in the market for gold ETFs, which have begun to see upticks in flows since this rotation began.
While the gold market is liquid, the means by which institutions access gold remains important. The rise of gold ETFs and other financial instruments has been a key development in that access. What Cavatoni says has become most popular is the use of a physical store of gold as the core allocation — gold bars stored in a vault. Gold instruments like ETFs or swaps are then used to add or subtract from that allocation. Physical gold becomes the strategic allocation, while financial instruments are used tactically. Gold equities, Cavatoni says, have become less popular in this rising price environment because their performance has tended to lag the rise in the overall gold price.
Even as pension funds consider allocations to assets like fixed income in a falling rate environment, Cavatoni continues to advocate for the role gold can play as a diversifier, a returns driver, and a source of portfolio protection.
“Gold will provide these pensions a buffer in the portfolio when things go wrong, it has that non-correlated behaviour and it does exactly what it’s meant to do,” Cavatoni says. “It’s also a highly liquid instrument that you can sell on a dime and realize what you need to realize.”
