Davy portfolios hold a strategic or long-term allocation to gold, not because we believe that the financial system will fail or that traditional currencies will be debased by inflation, but as an insurance policy against such scenarios being priced into financial assets. However, with the price up over 50% (in dollar terms) this year, and up over 100% in the past 2 years, we spent much of October debating the tactical or short-term outlook for gold.

The tailwinds for gold have certainly been strong in recent years. Inflation is still above target, liquidity levels are high and interest rates are coming down. Governments continue to run deficits and accumulate debt, with no convincing plans to bring these under control. Lastly, financial sanctions against Russia have led many central banks to build their gold reserves. However, even though this current bull run has been shorter than bull runs of the 1970s and 2000s, this has been the strongest year for gold since 1979, and there were concerning signs. By the end of September, trader positioning was very long, flows into gold ETFs were unusually strong1, and in the Bank of America global fund manager survey gold was identified as the most crowded trade in world markets, even more so than the Magnificent 7 tech stocks2.

Figure 1: Gold, silver and gold miner pull-back

Source: Bloomberg. All prices are in US dollars.

Then, in mid-October, with the gold price already up over 12% on the month, it turned and fell by almost 10% in 7 days. Silver, which had run up even more than gold this year, fell by 14%. The index of gold miner stocks, which we had investigated for a potential tactical allocation before it doubled in nine months, fell by 16%. At first the selling seemed to be happening in the futures market, suggesting that it was macro traders taking profits, although we did see some ETF outflows by the end of the month. Technical indicators did not break key levels, but they did come close, and for now it looks like an overdue cooling off from a very hot streak, which would be a healthy correction. We will continue to watch the price action for more signs of weakness, but given that the strategic insurance reasons to hold gold are still strong, we are reluctant to remove it. We did however take this as an opportunity to trim over-run positions back to their intended strategic weight. See the next section for details.

In our August letter, we explained our rationale for re-establishing our overweight position in the Japanese yen. In recent years it had fallen to lows not seen in decades, as the BOJ (Bank of Japan) kept interest rates at extreme lows while the rest of the world hiked rates to counter inflation. As price rises moderated elsewhere, Japan finally saw above-target inflation and the BOJ began to raise rates as the Fed and others began to cut. This narrowing of the rate gap was expected to reverse the depreciation of the yen, but by the end of the summer it had yet to make much difference. Then when Sanae Takaishi became prime minister in October, her impact on local markets came quickly, with the stock index rising and the yen weakening again.

Figure 2: The impact of Sanae-nomics on Japanese markets

Source: Bloomberg. Topix index is in Japanese yen.

Many commentators have noted the similarity between Prime Minister Takaishi’s policy ideas, dubbed Sanae-nomics, and those of Prime Minister Abe, introduced in 2012 and known as Abe-nomics. His ‘Three Arrows’ of aggressive monetary policy, flexible fiscal policy and structural reform brought a boost to the local stock market and a decline in the exchange rate, and so the reaction to Takaishi’s appointment is understandable. We note that macro and market conditions are very different from Abe’s time. Inflation was close to zero then, whereas it’s almost 3% now, limiting how much stimulus can safely be applied. The Topix stock index is now five times higher than it was in 2012, and the yen has declined by 50% versus the US dollar. The new prime minister could still bring fresh opportunities for Japan though, so we will continue to follow developments there.

1 An ETF is an exchange-traded fund, a financial instrument that trades on a stock exchange but can contain a variety of assets, including stocks, bonds and commodities.

2 The Magnificent 7 are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.