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The Experts

Michael Wayne
+ About Michael Wayne

Michael is managing director of Medallion Financial Group with a number of years’ experience in financial markets across a number of firms and institutions, specialising in financial strategies and investment management. Along with his team Michael provides advice to a range of clients in both domestic and international direct equities, exchange trade funds (ETFs), and listed investment companies (LICs).

Michael has been recognised by the various media organisations in Australia as a Stock Market expert, where he details his market insights daily across multiple business programs. In addition to this he writes for some of Australia’s key financial publications and conducts seminars for some of Australia’s most respected finical organisations.

Why aren’t rising rates hurting the gold price?

Wednesday, April 04, 2018


In the midst of a busy earnings period and captivating macroeconomic environment, commentary on the gold price, normally a hotbed issue in financial circles, has quietened somewhat. 

In an environment of threatening inflation, rising bond yields and rising geopolitical tensions, what to make of this intriguing but mystifying commodity?


The strange beast that is gold

Unlike the vast majority of commodities, gold rarely gets consumed despite being one of the most conductive elements on earth. Instead, it spends its days laying lifeless in secure vaults for years on end. It's for those reasons that gold arguably lacks the typical supply and demand characteristics that drive price discovery, instead leaving it up to human emotion and technical analysis to drive movements in price. 

Essentially gold has a valued attributed to it by investors betting on increasing fear in other investors, caused by a myriad of reasons ranging from fear of inflation, to fear of economic and political instability. The most common investment case for gold often prosecuted by investors, comes from its perceived "safe-haven" status that is meant to see gold help investors counter the numerous risks and uncertainties that may confront financial markets from time to time. 

Aside from investment demand, jewellery sales is the other primary driver of gold demand, with India and China leading a 4% recovery in jewellery demand in 2017, although demand remains down on historical averages. Gold's industrial demand is naturally limited by its price, nevertheless industrial demand grew for the first time since 2010 due to increased use in smartphones and vehicles. 

Bonds and gold’s inverse relationship breaking down

Up until recently, one third of the developed world's sovereign debt exhibited negative yields which in theory helped to drive investment demand for gold. Gold obviously doesn't pay a yield, but with bonds paying record low yields or in some cases negative yields (costing investors' money to hold the bonds), all else remaining constant, investors at the margin gradually developed a stronger preference for gold over bonds. 

Naturally, the two assets will never be completely interchangeable given the vast differences in 'price risk', nevertheless as illustrated in the chart below, a strong inverse correlation emerged between gold and the 10-year US Treasury bond price from the start of 2015 until the start of 2018. In recent months however, these dynamics have clearly shifted with the inverse correlation between treasuries and gold showing signs of breaking down.


In the United States the announcement of corporate tax cuts and infrastructure spending packages will likely see the budget deficit blow out from 3% to 5% at a point where the US economy is at full employment. This unprecedented move has stoked fears of a blow out in wages and inflation causing bond yields to move higher. So far, despite rising bond yields, the gold price has remained fairly resilient, leading investors to search for other factors supporting the gold price.

US Dollar now the key driver of gold?

With the decoupling of the of gold price and bond yields, it appears the US dollar has become the key driver of price. An interesting piece of research by Macquarie looks at the performance of the gold price during US dollar bull and bear markets dating back to 1980. What was found is that in months when the US dollar rises, for every 2.0% increase, the gold price on average declines 1.1%, while for every 2.0% decline in the US dollar, the gold price rises 1.3%.   

Since October 2017 there has been a clear shift in investor willingness to take on risk, comforted by low volatility and an improving global growth outlook. This improved sentiment and appetite for risk has seen the US dollar take on the role of a risk currency. When global growth is synchronised and strong, it’s not uncommon for money to flow out of the United States and into areas such as emerging markets, placing downward pressure on the USD in the process.

It therefore appears that at this stage the negative effects of rising bond yields on the gold price are being at least partially offset by the positive effects of a weakening USD.


Where to next?

The key question for investors going forward is what is the likely direction of the gold price from here?

Movements in the gold price are notoriously difficult to predict, with the proverbial streets lined with the graves of countless price predictions made by esteemed commodity analysts and research houses alike. From a technical perspective US$1300 appears to be a key level, however we think investors are best served to turn their mind to the USD and economic data for the direction.

There is a strong argument that the recent spate of synchronised global economic growth is reaching a peak, that's if it hasn't peaked already. Despite a strong jobs market, US GDP forecasts have been revised lower, European data has been noticeably softer, while the Chinese authorities continue to prioritise sustainable and environmentally conscious growth. 

On the political front and geopolitical tensions appear to be rising, whether it be related to the Russian Spy Saga, or threats of Tariff wars. Additionally, the upheaval inside the White House over recent weeks has also been conspicuous. 

With signs that global growth is decelerating and political tensions rising, we have seen the USD stabilise, a sign that investors are starting to feel less optimistic about the global outlook. Notably through, this recent period treasury yields have remained fairly stable. For an investor in gold, a stabilisation and eventual reversal in the USD is a key downside risk, particularly if the reversal coincides with a period of stability (or increase) in bond yields. 

Our conclusion is that despite a seemingly favourable political backdrop for gold, we don't think political tensions are significant enough at present to offset the economic backdrop of stable (or rising) bond yields, coupled with a stable (or rising) USD. We are therefore reticent to take new positions in the underlying gold commodity, ETF's or gold producers at this junction.

Our preferred exposures

For those investors looking for gold exposure, given its unpredictable nature we tend to limit exposure within a portfolio to 5%. When scouring the market for gold producers we prefer to break them into a couple of sub categories based on those that produce domestically and those that produce overseas. 

In the present environment, as a general rule we'd prefer to hold Australian based producers who incur their costs in AUD and sell the gold in USD. There are numerous gold producers in Australia who hold assets in places such as Papua New Guinea and Africa. These miners not only have greater sovereign risk, but they tend to incur their costs in USD as well as sell the gold in USD, therefore failing to benefit as much from a declining AUD. 

A couple of gold producers that meet the criteria in our eyes are Northern Star Resources (NST) and Evolution Mining (EVN). Both Evolution and Northern Star possess very strong balance sheets with manageable debt levels and significant cash reserves. As low to medium cost producers with high grades, these businesses are in a strong position to leverage off a rising gold price should that transpire. Both have performed very well for clients in recent years, however given the aforementioned reasons for being cautious on the outlook for gold we'd be looking to reduce positions and lock in at least a portion of profits.


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The best and worst sectors of 2017

Friday, December 22, 2017

By Michael Wayne

As 2017 draws to a close, it gives investors the opportunity to reflect on the year just past, and use those reflections to prepare for the year ahead.

The last year was a successful one for most key asset classes, with shares, property and fixed income securities all performing well over the calendar year. Once again global shares delivered the best performance, supported strongly by synchronised global growth, the spectre of US tax cuts and improving corporate earnings, leaving a bank-orientated ASX to continue a recent trend of perennial underperformance.

There has been a clear shift in investor willingness to take on risk, comforted by low global volatility and an improving growth outlook. The reality is, the traditional large capitalisation sectors, such as the banks and telecommunication sectors, have lost their lustre in the face of greater regulatory imposts and fiercer competition, respectively. As such, investors have found themselves searching outside the larger well-known names for something with a more attractive growth profile.

Source: Yahoo Finance


After several years of underperformance, a surge in ‘emerging leaders’ in the back half of 2017 has helped to propel the index higher, as investors piled into themes ranging from cobalt and lithium, to Chinese consumer related milk powder. The ASX 200 is up around 4.5% (exc. dividends) for 2017, however it’s the small and mid-cap space where the best returns could be had, up 11.5% and 14% respectively. Honourable mentions should also go to the recovery in mining services names, while the emergence of an effervescent technology space on the ASX attracted much interest and excitement. 

Although these thematical ‘stories’ indeed make sense, and the investment performance has been superb, it's important for investors to exercise caution going forward. In some instances, there are signs of investor overexuberance, with the expectations implied by some of the valuations appearing overly optimistic. At the very least, statistically, the indication is that small caps are historically expensive relative to both large caps and post-GFC averages.

Although the ASX lagged its global peers again in 2017, the index nevertheless managed to deliver solid back-to-back returns, activating the benefits of compounding for investors. As always however, if you dig below the surface a more diverse picture emerges. After being subject to a vicious selloff in the second half of 2016, the healthcare sector had a strong return to form in 2017, emerging as the best performing sector on the ASX, up in the vicinity of 23% at the time of writing. Strong earnings growth and confident outlook statements from the likes of CSL, COH, RMD and FPH helped support the sector, which looks set to continue to benefit from the structural tailwinds that will see the number of people aged 65 or over double over the next 15 years.


The second best performing sector for 2017 has been the Information Technology sector. Digital transformation is seeing corporates across the globe adopt new technologies at a rapid rate. Businesses such as WTC, NXT, XRO, ALU and even REA have all delivered strong performance in 2017, given their exposures to new age requirements such as cloud computing, data analytics & storage, and process automation. Pleasingly there are signs that the Australian Technology sector has evolved and is beginning to re-emerge after being cast aside as tired and insignificant in the face of imperious players such as the United States, Europe and China.

Access to investor capital, and identifying and retaining talented individuals are often cited as the major impediments to success for IT businesses, however it’s arguably the more ambiguous emotional factors such as investor risk tolerance and mentality, that have been equally debilitating for the industry in Australia. The signs are that all these factors are starting to shift favourably, and we fully expect the sector will continue to deliver in the years to come, although investors must remain particularly conscious of valuations.


The worst performing sector in 2017 was the Telecommunications sector for the second year in a row. It has been another frustrating year for holders of Telstra, with long-suffering shareholders appearing to have been caught up in a classic yield trap. Aggressive competition for NBN and mobile customers has placed downward pressure on margins for many of the key players in the space such as TPG and Vocus, at a time when these businesses are attempting to consolidate and pay down debt after years of mergers and acquisitions. In recent weeks some renewed life has come into the sector, perhaps as bargain hunters look for value in a market that has otherwise rallied strongly. Will this sector be a surprise packet in 2018 after a difficult few years? 

*Prices as at 15/12/2017

** Returns excluding dividends





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