This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Deborah Frame, vice president of investments at Toronto-based Cougar Global Investments.
There’s good news for gold investors these days. The yellow metal remains as the only safe haven when real interest rates are negative, as they are proving to be in this new era of global financial repression.
While gold does not pay any interest and may be 'unproductive,' cash, another relatively unproductive asset, is increasingly yielding negative real interest in an increasing number of economies.
It may be a narrow point decided by a slim number of basis points of negative yield, but it is a valid point.
The tangible inmplication is this: ETFs that hold gold bullion as the underlying such as SPDR Gold Shares (GLD | A-100) and iShares Gold Trust (IAU | A-99) have perfectly reflected the rebound and are ideally suited to benefit from the implications of these shifts.
The metal has rebounded in 2015, climbing about 2 percent, its highest price (around $1300) in five months following confirmation of European quantitative easing (QE) and turmoil in currency markets triggered by the Swiss National Bank.
The common view has been that slowing foreign economies are feared to become a drag on American expansion. As the dollar reached the highest level since 2004 against a basket of 10 major counterparts, the appeal of exports has been threatened.
The record of the January 27-28 Fed meeting confirms this concern in addition to international flash points from Greece to Ukraine and slow wage growth as weakening the case for the first rate rise since 2006.
Before diving into greater detail, a look at the chart below that depicts the prevalence of zero interest rates sets the stage well.
Gold Demand And The Swiss Franc
But there are two structural shifts impacting the demand for gold as a safe haven investment. Investors consider the Swiss franc as a “safe haven” asset, along with American government bonds and both have had structural shifts in demand imposed on them recently.
Let’s begin with the Jan. 15 Swiss National Bank’s action.
On that day, the Swiss National Bank removed the peg of 1.2 Swiss francs to the euro, introduced in 2011 in order to prevent capital inflows and appreciation of the currency.
The removal of the franc’s peg to the euro was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971, which, by the way, occurred three months after the abandon of Deutschmark’s peg against the dollar in May, 1971.
Investors have liked the franc because they think the Swiss government is a safe pair of hands: It runs a balanced budget. But as investors flocked to the franc, they dramatically pushed up its value.
An expensive franc hurts Switzerland because the economy there is heavily reliant on exports: exports of goods and services are worth over 70 percent of Swiss gross domestic product (GDP). To bring down the franc’s value, the SNB created new francs and used them to buy euros.
Increasing the supply of francs relative to euros on foreign-exchange markets caused the franc’s value to fall, ensuring a euro was worth 1.2 francs. By 2014, the SNB had amassed about $480 billion-worth of foreign currency, a sum equal to about 70 percent of Swiss GDP.
A Rapid Policy Change
Why did the SNB drop the peg so suddenly?
I see two primary reasons. First, many Swiss are concerned that printing all those francs will eventually lead to hyperinflation. Those fears are probably unfounded: Swiss inflation is too low, not too high. The SNB can print as many francs to prevent its currency’s appreciation as it wants. That luxury is unlike other central banks that defend their currencies against excessive depreciation and, thus, are limited by the size of their respective foreign-exchange reserves.