66 Finance & economics The Economist January 8th 2022
I
nflationissurging,centralbank
moneyprinting has run amok and
political tensions between the world’s
powers are intensifying. These ingredi
ents sound like a waking fantasy for
ardent believers in the longterm pro
mise of gold. Even mainstream investors
might have been tempted to increase
their holdings of the precious metal.
Why then was it unable to eke out even a
marginal gain in 2021, recording its worst
annual performance in six years?
For conventional investors, valuing
gold poses a problem. The precious
metal does not generate a stream of
income. Since demand for it tends to be
speculative, the cashflow models used
to work out whether assets are cheap or
expensive cannot be applied.
One measure, however, contains
predictive power. Every big move in the
price of gold, particularly in the period
since the global financial crisis, has been
inversely correlated with moves in real
interest rates. There are few financial
relationships that have held up as well as
that between the price of gold and the
yield on inflationprotected Treasuries
(tips). The lower real, safe yields are, the
greater the appeal of an asset without a
yield that may rise in value.
Part of the explanation for gold’s
underwhelming performance last year is
that this relationship continued to hold.
Despite the frenzy over inflation, ten
year real interest rates began the year at
1.06% and ended at 1.04%. Gold ended
2021 at around $1,822 per troy ounce,
practically flat on the year. Over the past
decade, though, gold has been the less
reliable of the two. If you had simply held
the iShares tipsbond exchangetraded
fund in that time you would have made
35%, more than double what you would
have earned by holding gold. Regulation has also dulled the precious
metal’s sheen. New rules on bankfunding
ratios, as part of the Basel III accord, came
into effect in the euin June and in Britain
on January 1st. These consider govern
ment bonds to be “highquality liquid
assets”. By contrast, holders of gold, like
those of equities, must match 85% of their
holdings with funding from stable sourc
es. That makes gold costlier for banks to
hold, and puts it at a disadvantage com
pared with Treasuries. If the yellow metal
is simply a less reliable proxy for tips,
without the friendly regulatory treatment,
why bother?
The answer for some investors would
once have been clear. Paper money and
governmentissued bonds are ephemeral,
and catastrophic failures of financial
systems often stem from overconfidence
in their safety. But gold, the argument
goes, has stood the test of time. The dollar
became America’s national currency only
in 1863. People have prized precious met
als for millennia.
Yet gold’s status as the final line of
defence against currency mismanagementis also being contested. Cryptocurren
cies, particularly bitcoin, are increas
ingly found in more mainstream portfo
lios. The asset class was once too small to
dent the appetite for gold. Now bitcoin
and ether, the two biggest cryptocur
rencies, have a combined market capital
isation of around $1.3trn, ten times what
it was two years ago. That is around a
tenth of the perhaps $12trn of gold hold
ings, based on the World Gold Council’s
estimate that a little over 200,000 tonnes
of the yellow metal exists above ground.
In 2020 Chris Wood of Jefferies, an
investment bank, and a longtime ad
vocate of gold, signalled which way the
wind was blowing. He cut his rather
sizeable recommended allocation to
physical bullion for dollarbased pen
sion funds from 50% to 45% and redi
rected the five percentage points to
bitcoin. In November last year he did the
same again, raising the bitcoin allocation
to 10%, at the expense of gold.
Bitcoin’s wild price swings may for
now limit the interest of the more con
servative gold bug. Over the past five
years the gold price has moved—both up
and down—by an average of 0.6% a day,
compared with a daily move in bitcoin of
3.5%. But that need not be a showstop
per in the long run. As analysts at Mor
gan Stanley have noted, gold also began
its life as a modern investment asset in
the mid1970s and early 1980s with bouts
of extreme volatility. It took almost two
decades after the ownership of gold was
legalised in America in 1974 for it to
become widely held by institutions.
A spell of comparative irrelevance for
the metal, then, cannot be ruled out.
Stuck between more reliable, safe assets
on one side and more exciting, spec
ulative cryptoassets on the other, gold
now finds itself in an awkward position.ButtonwoodLost lustre
Why some of gold’s charm has fadedinvestment officer of direct indexing at Na
tixis, a bank. “There’s a goldrush mentali
ty,” reckons Tom O’Shea of Cerulli.
Direct indexing has both benefits and
costs. Its main selling point is its ability to
lower tax bills. This is achieved primarily
through a process called “taxloss harvest
ing”, which involves selling and replacing
losing stocks to offset gains in winning
ones, thereby reducing capital gains sub
ject to taxation. Although this technique
can generate returns on the order of 11.5%
per year, the benefits are close to nothing
for individuals in lower tax brackets, or forinvestors who hold the bulk of their assets
in retirement accounts, such as 401(k)
plans, which defer taxes on investment
gains until funds are withdrawn.
Another advantage of these accounts
over conventional mutual funds or etfs is
customisation. For ethically minded punt
ers, this could mean excluding fossilfuel
producers, tobacco companies or weap
onsmakers. The more customisation, the
greater the likelihood that portfolio re
turns diverge from benchmark returns.
Directindexed accounts are often char
acterised as a disruptive threat to mutualfunds and etfs. In truth they are part of the
same longterm trend. “This is really about
the growth of indexing,” says Mr Small of
BlackRock. “The growth of direct indexing
and etfs go together, they’re just different
ways to gain index exposure,” he adds. Bri
an Langstraat of Parametric Portfolio Asso
ciates says that the primary driver of direct
indexing is not lower costs or fractional
shares but the decadeslong shift towards
passive investing. “The trends that are be
hind it are thesameones as five years ago,”
he says, “andwillbethe same ones five
years from now.”n