Gold beyond the cyclical narrative

Federated Hermes versus Man Group: Head-to-Head This week FSA compares the Federated Hermes Asia ex-Japan Equity fund and the Man Asia (ex Japan) fund. The case for gold is structural not cyclical, according to James Luke, lead manager of the Schroders Global Gold fund. During the past three months, gold has faced significant headwinds. A stronger dollar, changing expectations for US interest rates, and renewed confidence in US economic exceptionalism have weighed on sentiment. For investors focused solely on the next Federal Reserve meeting, these factors may seem reason enough to keep away. But that perspective misses the broader picture, according to James Luke, lead manager, Schroders Global Gold fund, and fund manager, emerging debt and commodities. “The case for gold is not simply a cyclical call on rates. It is a structural response to a world of heavy debt burdens, loose fiscal policy, geopolitical fragmentation and a gradual erosion of confidence in the dollar-based system,” he said in recent note. These issues have not faded; in fact, they have become even more relevant. Developed economies are now burdened with debt levels far higher than in previous tightening cycles. The notion that central banks can simply repeat “the Volcker playbook of the early 1980s” is unrealistic, Luke noted. Today’s economies face much larger deficits and far greater sensitivity to interest costs, operating within tighter political and fiscal constraints. “That matters for gold because the metal is, ultimately, a hedge against currency debasement,” said Luke. “If governments continue to run loose fiscal policy and try to outrun their debt burdens through nominal growth, then money supply is likely to keep growing faster than real economic output. In that environment, gold’s role as a store of value remains extremely relevant.” Moreover, fiscal and monetary challenges are not unique to the US. Japan, China, the UK, and parts of Europe face similar pressures. When confidence in the dollar-based system is questioned, gold stands out as one of the few assets outside that framework. Indeed, “the world is moving toward a more multipolar order,” argued Luke. US influence, though still strong, is increasingly challenged, and the willingness to weaponize the dollar system creates incentives for countries to diversify away from dollar assets. “Central bank gold buying is clear evidence of this shift. Emerging market central banks, in particular, still hold less gold as a share of reserves compared with developed market counterparts—leaving significant room for further purchases. China’s gold reserves, for example, remain small relative to its total holdings. Any meaningful increase in allocation would require sustained buying over time, given the constraints of annual global supply. This dynamic underscores why the gold market should not be judged solely by Western ETF flows or short-term rate expectations, according to Luke. “Western investors may still treat gold as a cyclical hedge: buy it when the Fed is cutting, sell it when the Fed sounds hawkish. But emerging market central banks appear to be treating gold as a strategic reserve asset. That is a very different type of demand,” he said. Despite recent strength, gold equity valuations remain low relative to bullion. Many gold producer shares are priced as if gold were trading well below spot, yet sector economics have improved dramatically. Gold producers benefit from high spot prices and relatively low production costs, resulting in robust margins. For example, a producer selling gold at around $4,000 an ounce with costs near $1,800 is generating margins more than double those seen in 2020. Unlike bullion, gold miners generate cash flow, pay dividends, buy back shares, and strengthen balance sheets. Many now enjoy high free cash flow yields and net cash positions. Yet, valuations remain near historical lows by most metrics. This creates an unusual opportunity, according to Luke. While gold equities are still mining stocks sensitive to gold prices, downside risk is now cushioned by higher margins. Even a sharp decline in gold would leave many producers generating meaningful free cash flow—a marked improvement from 2022, when thinner margins left balance sheets more vulnerable. In fact, “the upside is spectacular”, said Luke. “As investors begin to accept gold as a structural portfolio asset rather than a temporary hedge, we believe gold equities could rerate materially. They offer operational leverage to a strong gold price, but without the same balance sheet fragility seen in past cycles,” he said. However, the gold equity universe is highly dispersed. Producers, royalty companies, developers, and mid-cap miners all behave differently, creating opportunities for both top-down allocation and bottom-up stock selection. The strategy focuses on Asian technology innovators. 88% of strategists believe productivity gains from AI will translate into higher corporate profits. Multi-asset funds remained the strongest-performing asset class during the first half of this year.