Got Gold?

2016 starts with a bang for bullion prices. Ready...?

WHO says gold lost its appeal as a safe haven asset? asks Frank Holmes at US Global Investors.

After five straight positive trading sessions in the first week of 2016, the yellow metal climbed above $1100 per ounce – its highest level in nine weeks, on a weaker US Dollar.. The rally proves that gold still retains its status as a safe haven among investors, who were motivated by a rocky Chinese stock market, North Korea's announcement that it detonated a hydrogen bomb last Wednesday and rising tensions between Saudi Arabia and Iran.

Here in the US, gold finished 2015 down 10.4%, its third straight negative year. Until the New Year, sentiment appeared poor, and many gold bulls were finding it hard to stay optimistic.

But after the price jump last week, large exchange-traded gold funds saw massive inflows, confirming a shift in investors' attitude toward the precious metal.

It's worth remembering that about 90% of physical demand comes from outside the US, mostly in emerging markets such as China and India. In many non-Dollar economies, buyers are actually seeing either a steady or even rising gold price. The metal is up in Russia, Peru, South Africa, Canada, Mexico, Brazil and many more.

Note the differences in returns between gold priced in US Dollars and gold priced in the Brazilian Real, Turkish Lira, Canadian Dollar, Russian Ruble and Indonesian Rupiah.

Gold demand in China was very robust last year. A record 2,596.4 tonnes of the yellow metal, or a whopping 80% of total global output for 2015, were withdrawn from the Shanghai Gold Exchange. As for the Chinese central bank, it reported adding 19 more tonnes in December, bringing the total to over 1,762 tonnes. Precious metals commentator Lawrie Williams points out, though, that China's total reserve figure is widely believed to be "hugely understated", meaning the central bank might very well have much more than we're being told.

Despite all the talk of rising interest rates in connection to gold, they're not a dominant driver of prices. Sure, rising nominal rates have tended to make the metal less attractive, since it doesn't pay an income, but the larger driver by far are real interest rates. When real rates drop into negative territory, gold has historically done well.

As a reminder, real rates, important for the Fear Trade, are what you get when you subtract the consumer price index (CPI), or inflation, from the 10-year Treasury yield. As of January 6, the 10-year yield was 2.18%, while the 12-month CPI for November – December data will be released later this month – came in at a barely-there 0.50%. Real rates, therefore, are running at a positive 1.68%, which is a headwind for gold.

That's why we need inflation to pick up, because then gold would be more likely to rally.

Regardless, the World Gold Council (WGC) writes in its 2016 outlook that gold's role as a diversifier remains "particularly relevant":

"Research shows that, over the long run, holding 2% to 10% of an investor's portfolio in gold can improve portfolio performance."

The reason for this is that gold has tended to have a low correlation to many other asset classes, making it a valuable diversifier. During economic contractions, for example, gold's correlation to stocks actually decreased, according to data between 1987 and 2015.

For the last three years, gold has disappointed many because other investments, specifically equities, have seen such huge gains. But with global markets hitting turbulence, the yellow metal is looking more attractive as insurance against the currency wars.

I always recommend 10% in gold: 5% in gold stocks or an actively-managed gold fund, 5% in bullion and/or jewelry. It's also important to rebalance every year.

This should be the case in both good times and bad, whether gold is rising or falling. As highly influential investment expert Ray Dalio said last year: "If you don't own gold, you know neither history nor economics."