Christopher Cruden makes the case for investing in gold by treating it as a major currency

It’s not true. Economist John Maynard Keynes did not say gold was a “barbarous relic”. He was, in fact, commenting on the gold standard in force in the early 1920s. This little-known trivia should be good news nearly a century forward for all those institutions which, either for reasons of formal investment strategy, inflation hedging or perhaps plain nostalgia, maintain some exposure to gold, even though many economic commentators see this as old-fashioned.

Traditionally, investment in gold has taken the form of a portfolio of gold-mining stocks, participation in a fund such those as offered by BlackRock or Vanguard or, less commonly, a holding of gold itself, perhaps via certificates. With the advent of ETFs, the balance has swung somewhat more towards direct exposure to the metal but whatever the vehicle chosen, the price of gold remains the pre-eminent driver of performance.

For the first decade of the millennium, accurately until late-July 2011, following the price turned out to be a good idea as gold moved from below $300 per troy ounce to peak at over $1,880. Those days are gone and institutions which tried to ameliorate the effects of the financial crisis through continued gold holdings found themselves taking a deep bath as the price faded to $1,780 through September 2012, when it then fell by some 40% to little more than $1,050 per ounce in 40 months. It recovered to the $1,200-1,300 range it occupies at the time of writing – and will continue to occupy for some time, if a poll of professional gold analysts conducted by the London Bullion Market Association is to be believed.

The problem is it’s hard to apply active management to a gold portfolio. Yes, one can finesse the equity holdings, perhaps touch the gearing but, in the end, the majority of approaches are beta-rich buy-and-hold (more accurately ‘buy-and-hope’) strategies primarily dependent on a bull market for precious metals.

The majority, but not all. In a January 2015 article in Global Quantitative Strategy Monthly researchers at Nomura, looking at five-year returns, came to the general conclusion that “traditional long-only commodities exposure is wrong” and that “commodities are as much of a macro-asset class as equities or fixed income”. This viewpoint redefines the word ‘exposure’ proposing active bi-directional strategies to replace conventional upside-focused portfolios. But how can such an approach be applied to gold?

A solution is to treat gold as a major currency, with no directional bias, and to trade it in crosses against formal major currencies. The vast, 24-hour liquidity of the international gold market, higher, it is claimed, than all currency crosses bar dollar/euro and dollar/yen, underlines this opportunity.

An investment strategy that employs this approach, trading the metal in crosses against major currencies such as the US dollar, euro, sterling and Swiss franc, has achieved significant but high volatility returns which, while not correlated to the gold price, do exhibit some linkage to the strength of price moves in either direction. It appears that this approach may provide a hedge against larger negative moves as well as a driver of overall portfolio performance.

One major currency presently missing from any investment mix is, for reasons of tight exchange controls, the Chinese renmimbi. However, given that China is, at the same time pretty much the world’s largest producer and consumer of gold and that, in April, the Shanghai Gold Exchange announced a local currency gold price fix to challenge London’s century-old dominance, it is to be hoped that a future investment strategy along the lines described,

will be able to take advantage of a loosening of Chinese FX restrictions. However, it is impossible to predict the impact of the renmimbi’s inclusion in a portfolio.

To conclude, a systematic approach to gold investment focused firmly on a statistical view of the numbers (that is, price expressed in a series of currencies) while ignoring more conventional research involving, among other elements, mining data and global economic forecasting, appears to be able to make an important contribution to a gold-based portfolio. 

On the evidence of this individual if high volatility approach, positive returns are achievable whichever way the gold price is moving, particularly if it is moving strongly. For this reason, institutions which require active exposure to gold, and indeed those that do not, should perhaps be encouraged to review the gold-is-currency angle. 

Christopher Cruden, CEO, Insch Capital

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