The Golden Gamble for South African investors

The JSE All Share has had a strong first half of the year on the back of soaring share prices for gold mining companies on the exchange. 

However, the market is now at a crossroads, with questions over whether the rally in the gold price can be sustained and what could drive the price higher.

Portfolio manager at Stanlib, Kobus Nell, said there has only been one constant in the history of the gold price over the past sixty years – its link to the value of the US dollar. 

Before 1933, in the Gold Standard Era, the price of gold was effectively fixed as most currencies were pegged to the precious metal. 

Central banks held gold reserves and issued currency in proportion to those reserves, thereby giving the paper money its value. 

This fundamentally changed as the United States, using its position as the dominant global economy, devalued the dollar and forced other countries to peg their currencies to the dollar, with the greenback being pegged to gold. 

The US, however, could not maintain gold convertibility later in the period amid growing deficits. As confidence in the dollar faltered, speculation and arbitrage became rife and gold demand increased, unlocking the door to unofficial markets, which priced gold above $35/oz.

This development ushered in the Floating Gold Era (1971-present), a period marked by market-determined gold pricing.

Since then, the price of gold has been much more volatile, with little certainty as to what is determining the value of the precious metal at any given point. 

From a hedge against inflation, being a safe haven, to central bank buying and jewellery demand, the price of gold is influenced by many factors. 

Recently, the price of gold has surged on the back of increased central bank buying and heightened global uncertainty following the United States’ implementation of tariffs on imported goods. 

Nell explained that investors have fled dollar-based assets due to this, with many rushing to gold for its stability and reputation as a safe haven. 

South African gold mining shares have skyrocketed as a result, pushing the JSE All Share to all-time highs and taking up a greater share of the index. 

While South Africa does not produce nearly as much gold as it once did, many miners are still listed on the JSE, including AngloGold Ashanti, Gold Fields, DRDGold, Harmony, and Pan African Resources. 

Some of these shares are now among the top six largest within the JSE All Share Index, thanks to the rise in the price of gold. 

This is illustrated in the graph below, courtesy of Nell and Stanlib. 

South African assets on the edge

It is not uncommon to see a strong price rally in gold while the US dollar weakens, especially when American policies have affected confidence about the health of the US and its reserve currency status. 

At the same time, the relationship between gold and US real rates has not been clear and has varied since the turn of the century, Nell explained.  

The last time since 2001 that the United States experienced the current high level of real rates was when its economy emerged from the Global Financial Crisis.

At that time, the gold price displayed a negatively correlated relationship with US real bond yields in line with a strong US dollar.

The way that financial markets have expressed dissatisfaction with US tariff escalation has been to dump US Treasuries. This pushed yields higher and pulled down the value of the dollar. 

If President Trump continues to backtrack on the level of tariffs initially announced, the dollar could arrest its weakening trend and potentially gain back some of the lost ground, Nell said. 

This, in turn, could cause a decline in the unwavering support for the gold price that has been evident lately, which has pushed the yellow metal to its second-most-overbought level since the late 1960s.

Although there are likely to be short- to medium-term headwinds for the gold price as Trump dials down on the intensity of tariffs, this does not diminish the benefits of including gold in a well-diversified portfolio over the longer term. 

History has shown that it remains an excellent store of value over longer periods, and, from a strategic perspective, we include gold in our asset mixes for the funds we manage.

South African gold shares, however, are currently showing the highest spread relative to the volume and margin-adjusted spot gold price in the last 10 years, which makes them vulnerable to any sign of a pullback in the gold price, Nell warned. 

This can be seen in the graph below.