Financial markets have seen considerable volatility this year, following concerns about global growth, various political events and questions about the next steps by central banks, all of which have contributed to fueling uncertainty. Investors carefully observe every statement released by the Federal Reserve, while the same, in parallel, monitors the evolution and trend of the parameters of the American and international economy. Despite a strong recovery in June in US private payroll data from weak forecasts, interest rates remained stable in July, partly due to the Brexit phenomenon in the United Kingdom, which reduced growth expectations at the level world.
Against this backdrop, many investors hold historically high levels of cash. In light of this situation, we have seen few and conflicting investor convictions since the beginning of the year. Looking at Exchange Traded Products (ETP) flows, we have noticed that gold has been one of the few asset classes able to gather flows on a consistent basis, especially during the sharp market contraction at the beginning of the year, when the correlation between gold and the US stock volatility index (VIX) hit an eight-year high.
After a high level of purchases of gold ETPs between January and February, followed by a contraction following an interest in riskier investment themes between March and April, global ETP investors showed a newfound and marked preference for gold and fixed income products over equity products. Following the strong collection of gold ETPs in May, inflows for physical gold funds and mining ETPs continued in June, raising an additional $5,4 billion. This has driven total flows of gold ETPs to $22 billion since January, a new yearly record, although there are still six months to go until the end of 2016. The previous peak for gold ETPs was to $17 billion recorded in 2009. Looking at other asset classes, as of mid-year, fixed income flows look set for a record year.
Since gold traditionally represents a guarantee of value in times of uncertainty, a "pessimistic" trajectory on interest rate hikes by the Fed, compared to expectations at the beginning of the year, seems to have renewed interest on the part of investors with a consequent rise in the price, above 1.310 dollars per troy ounce. Looking ahead, a potential rise in the US inflation rate could confirm the appetite for investing in gold, as it is often and commonly believed to be an inflation hedge, with varying degrees of effectiveness. This theory could be tested again shortly given the recent rise in some US inflation metrics, such as the consumer price index (CPI).
In a broader perspective, some political issues could contribute to the uncertainty during the second half of the year, together with the current worries about global growth prospects, and - especially - in the event of a downturn in the US economy. To further aggravate this scenario, there is the possibility that investors will lose confidence in the effectiveness of central bank policies, such as quantitative easing. Hedging risk, as a measure against volatility, appears to remain the most relevant strategy in portfolio management. We believe investors may still want to consider gold exposure, despite its sharp price gains over the past year, due to its "safe-haven" qualities and because, as is the case with many alternative investments, it diversification within the portfolio.
We have recently carried out some analyzes on various alternative investments to understand what could be a good element of diversification within a portfolio, both in terms of risk and return. For example, for a standard allocation of 60% bonds and 40% equity over the past 8 years, we observed that an optimal combination of gold and broader commodity exposure would reduce overall portfolio volatility, while a combination of gold and other precious metals would have made the portfolio more efficient overall, with lower risk and higher returns. Overall, the analysis highlighted benefits from alternative exposures, with gold and commodities being the best diversifiers historically. Despite the growth in recent months, we believe gold is likely to remain an attractive investment due to its inherent diversification characteristics and, potentially, risk and return benefits
