Gold’s role in Australian portfolios amidst rising interest rate volatility

Highlights

• Recent inflation data and Reserve Bank of Australia (RBA) comments have reset expectations of interest rate cuts
• Volatility in rate expectations and elevated yields may amplify traditional portfolio risks
• Gold is a strong performing asset with low correlation to local equities and bonds that can help improve the performance of Australian portfolios
• Y-t-d, gold, in AUD, has generated a return of 22%, outperforming most other assets

Hike?...cut?...hike?

Following two consecutive months of hotter-than-expected Australian CPI prints, it was a surprise to many that June inflation eased (Chart 1). The headline June inflation (trimmed mean) came in at 4.1% y/y, down from 4.4% in May. Meanwhile, the RBA's Q2 trimmed mean inflation figure was down to 3.9% y/y, lower than both Q1's 4% and the consensus (4%).

Sources: Bloomberg, World Gold Council; Disclaimer

While inflation remains well above the RBA's target range of 2-3%, signs of deceleration encouraged investors. Following release of the June and Q2 inflation data, market expectations of the RBA's rate path took a 180-degree turn: from rate hikes to potential cuts by late 2024.

But these expectations were short-lived. The RBA monetary policy meeting on 6 August the following week dashed investor hopes by maintaining rates at their 12-year peak and stating that it expected inflation to take longer to return to target compared to prior forecasts (Chart 2). The bank cited a strong demand outlook, elevated wage growth and the still tight labour market as the main drivers behind its conclusion. At the media conference after the meeting, Governor Michele Bullock mentioned that there would be no cut on the agenda for the next six months and that the RBA will remain open to further tightening due to the upside risks of inflation.

Sources: Reserve Bank of Australia, World Gold Council; Disclaimer

Sources: Bloomberg, World Gold Council; Disclaimer

What does this mean for Australian portfolios?

We believe that these events have two main implications. First, in the near term, when upside risks of inflation remain elevated, the correlation between bonds and equities is likely to stay high. We have been witnessing such a pattern between 2022 - when the RBA started hiking - and now (Chart 4).

Second, government bonds yields may become volatile depending on the course of inflation and on how much the central bank's sentiment shifts - similar to the pattern we have seen recently. While local bond volatility has already been pushed to a multi-year high, the aforementioned uncertainties may keep it elevated.

Chart 4: Heightened bond volatilities and a very high correlation between bonds and equities*

Sources: Bloomberg, World Gold Council; Disclaimer

Sources: Bloomberg, World Gold Council; Disclaimer

Gold as a strategic component in Australian portfolios

In the face of rising volatilities we believe gold can provide diversification benefits for Australian portfolios. Unlike bonds, gold has demonstrated a consistently low correlation with Australian equities (Chart 6). This is mainly because gold's valuation is not determined by any one country thanks to its diverse sources of demand - which spreads across regions and sectors - and supply.

Chart 6: The correlation between Australian equities and gold, in AUD, has been consistently low over the past decade*

Sources: Bloomberg, World Gold Council; Disclaimer

Sources: Bloomberg, World Gold Council; Disclaimer

Conclusion

As global financial markets witness increased volatility, geopolitical risks show no signs of abating and, in Australia, uncertainty remains about the future path of interest rates, Australian investors face challenges in their quest to effectively manage their portfolios. Gold offers a low correlation with local equities and attractive return prospects while acting as an effective hedge against geopolitical risks. As such, gold is an ideal asset to enhance return and reduce risk in Australian portfolios.