Why have gold ETFs lost their shine so far this year?

After a stellar 2020, gold has struggled so far this year thanks to rising bond yields. 

Gold was one of the most popular assets in 2020. The precious metal started the year at about $1,500 per ounce, reaching just over $2,000 by August, representing a new all-time high. From there, the price of gold started to come off, ending 2020 at about $1,800 an ounce.

There were several popular narratives explaining this strong price performance. First, many pointed to gold’s appeal as a safe-haven asset. Due to the pandemic, financial markets were highly volatile in 2020, leading investors to seek safety in gold.

Another explanation focused on the decline of bond yields. In response to the economic fallout of the pandemic, central banks cut interest rates to historic lows. As a result, the yield on bonds reached all-time lows, giving investors a negative real rate of return in many cases, and making zero-yielding assets such as a gold appear more attractive.

The third explanation focused on inflation. According to this view, investors were buying the precious metal as a hedge against runaway inflation. Governments around the world had opened up the fiscal taps while central banks were pursuing ultra-loose monetary policy. All of that extra money would eventually lead to price rises, it was argued.

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Since then, however, the performance of the yellow metal has reversed sharply, with the average gold-price tracking ETF losing over 10% since the start of the year (in sterling terms). According to data from FE Analytics, the iShares Physical Gold ETC  (LSE:IGLN)has lost 11.3%, as has the Invesco Physical Gold ETC (LSE:SGLD). Xtrackers Physical Gold (LSE:XGLD)lost slightly more, with its year-to-date returns sitting at -11.5%. HANetf’s Royal Mint Physical Gold ETC (LSE:RMAU) did slightly better, with a loss of 11.2%.

Meanwhile, ETFs tracking the share price of gold miners have lost slightly more. The iShares Gold Producers UCITS ETF (LSE:IAUP) has lost 12.2% and the VanEck Vectors Gold Miners (LSE:GDX) is down 12.7%. The worst was VanEck Vectors Junior Gold Miners (LSE:GDXJ), declining by 17.1%.

This poorer performance has also seen increasing amounts of money leave gold ETFs. According to data from the World Gold Council, gold-backed ETFs lost 2% of their assets under management in February. That marked the third time in four months that gold ETFs saw more money withdrawn than invested.  

Actively managed gold funds also largely did worse. LF Ruffer Gold Fund has lost 14.5% since the start of the year, while BlackRock Gold & General is down 13.31%. The worst performer, however, was Ninety One Global Gold, giving up 18.8%.

So what’s happened? In a word, reflation. In November, when the viability of vaccines became apparent, the outlook for the global economy markedly improved. On top of that, the election of Joe Biden as president of the US increased expectations for a large US stimulus package. All that has seen the performance of value and cyclical stocks increase at the expense of growth and quality stocks, as investors expect the economy to roar back this year.

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Another effect, however, has been a steady decline in bond prices and a pick-up in bond yields. Bonds tend to perform less well in times of strong economic growth. On top of that, the $2 trillion fiscal package of the new Biden administration means the US government issuing more bonds, which some fear may further push yields up through increased borrowing. But most importantly, in recent months there has been growing concern that the economic recovery may be “too strong”, leading to a meaningful pick-up in inflation rates. With higher inflation expectations, investors demand higher yields on bonds. As noted above, rock-bottom yields in 2020 made gold relatively more attractive, boosting its price. Therefore when bond yields go back up, the price of gold should go down.

But what about the idea that investors were buying gold to protect against inflation? Surely the recent pick-up in inflation expectations is vindication of their fears and therefore should boost the price of gold if it is a supposed hedge against inflation?

Perhaps the inflation fear-induced gold buying was always a minority view among investors, albeit one that attracted lots of attention. Maybe in reality, most gold buying was the result of lower bond yields meaning that gold, at least in the short term, is actually negatively correlated with inflation expectations.

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However, if higher inflation expectations worsen, it is still possible for gold prices to go back up again. As Adam Perlaky, manager of investment research at the World Gold Council, notes: “While higher rates are a short-term headwind for the gold price because they increase its opportunity cost versus bonds, growing expectations for inflation could partially offset this impact.”

It is also worth noting that the price of gold is still above its level at the start of 2020.

Another view, however, is that those worried about runaway inflation are increasingly opting for another asset as a hedge against inflation - bitcoin. As readers will know, the price of bitcoin and a few other cryptocurrencies have increased dramatically in recent months. Advocates of bitcoin often also express fears of runaway inflation and claim cryptocurrencies can act as a hedge against this. Perhaps many of these inflation-fearing investors have instead opted for cryptocurrencies as their preferred assets.