9th November 2010

Schroders - Gold: another bubble waiting to burst?

All the talk of currency wars and a new round of quantitative easing by the US Federal Reserve have lifted gold prices from one all-time high to another. With prices up more than 25% so far this year, gold is heading for its 10th consecutive annual gain - its longest winning streak in almost a century - outperforming global equities, bonds and most other commodities. In times of uncertainty and austerity, nothing glitters quite like it. But - as gold takes the medal for one of the best-performing asset classes of the last decade - many investors are concerned that the relentless rise in prices is taking gold into 'bubble' territory. However, in these uncertain times, gold may be one of the few assets classes with the potential to appreciate still further.

As a traditional store of value, gold has always been something of a quasi-currency but what is unique about its recent surge is that investors are not buying gold for quite the same reasons they once did. For decades, gold was seen as a hedge against inflation but, in these times of tepid growth, inflation is not, for the moment, a major concern for most economies. For this reason, inflation cannot be blamed for driving gold prices to the unprecedented highs of recent weeks. Instead, it is uncertainty and currency devaluations - related to the consequences of further QE - that is driving investors into the safety of gold.

From an investment point of view, I see gold as a good defensive asset when times are as uncertain as they are now. With investors still nervous about the double dip, unsure about equities and lamenting signs that bond yields will stay low for a long time, I see no reason why gold won't appreciate further. The downside is that it pays no income and its intrinsic value is based solely on what someone else is willing to pay for it. At present, however, this continues to be quite a lot.

People who worry buy gold - and at present many people are worried. Paper currencies are being, if not actively depreciated, talked down by central banks around the world. Fears of an all-out currency war have moved to the top of the global political agenda as currency becomes the new weapon of choice in the economic battle between east and west. Growth in Asia is based on an export-led model which requires a competitive currency. This spectre of currency dilution has been compounded over recent weeks by the possibility that central banks in the west will turn the printing presses back on. As mentioned earlier, gold is often considered a quasi-currency but, unlike paper money, banks cannot churn out unlimited amounts of it. As an asset that pays no interest, gold will suffer when rates rise, but with rates likely to stay low for a considerable time, and with more QE announced by the Fed last week, gold prices should remain well supported. Far from being in a bubble, gold prices could still have some way to go.

Important Information:
The views and opinions contained herein are those of Paul Duncombe, Head of Multi-Asset Investment Solutions, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

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