Markets became nervous that the new president’s 25% tariff on imports from Canada and Mexico and 10% levy on Chinese goods could trigger a trade war that would alter global trade dynamics.

Gold’s price reached £2,275 per ounce today (3 Feb), up from £2,103 at the beginning of January.

Funds such as Baker Steel Gold & Precious Metals, Jupiter Gold and Silver, and BlackRock Gold & General benefited the most from this surge in demand, beating all other Investment Association funds with total returns of 17.4%, 17.3% and 16.6% in January.

See also: Global markets fall as Trump tariffs spark trade war concerns

Following close behind them was Charteris Gold & Precious Metals, Quilter Precious Metals Equity, and Ninety One Global Gold, which were up 16.3%, 16.2% and 16.1% respectively throughout the month.

And gold’s rally could have further to climb yet, with many unknowns still lingering over how the affected countries may react – not to mention the nations that could yet have tariffs placed on their goods.

Russ Mould, investment director at AJ Bell, said: “The prospect of a full-blown trade war has spooked investors as they weigh up the prospect of widespread retaliation by countries on the receiving end of Donald Trump’s tariff frenzy,”

“Affected countries aren’t going to take the hit lying down and a tit-for-tat scenario is now looking real. That could result in higher inflation and put a stop to further interest rate cuts for the time being – exactly the opposite of what equity investors want to happen.”

See also: Baillie Gifford drops sustainable tag from £159m monthly income fund

On a sectoral level, IA Latin America had the best month in January, rising 11.4% on average thanks to its high exposure to commodities. Funds in the sector collectively hold over a third (35.3%) of their assets in basic materials and industrials.

But IA Latin America’s strong month could be short lived, according to Ben Yearsley, investment director at Fairview Investing. After being the worst performing sector of 2024 (falling 25% on average), last month could be a “dead cat bounce,” he said.

India delivers worst returns

Commodity portfolios may have had a strong start to the year, but IA India funds suffered the worst returns in January as the nation forecast its slowest economic growth in four years.

The latest Economic Survey projected gross domestic product to grow by 6.3% to 6.8% over the coming year, down from 8.2% last year.

Funds in the IA India sector fell 5.2% on average throughout January, with some dropping further than others.

Invesco India Equity was the worst performing fund of the month, with returns dropping 10.6%. It was followed by Ashoka Whiteoak India Opps and Comgest Growth India, which fell 9.6% and 9% respectively.

The strategy, which has a 0.55% total expense ratio, will list tomorrow (15 January) on the London Stock Exchange. It is also available to European investors on the Börse Xetra and Borsa Italiana.

Classified as an article 8 SFDR fund, it aims to offer investors access to commodities associated with energy transition themes such as electric vehicles, transmission, charging, energy storage, solar, wind and hydrogen production.

See also: SJP equity fund aligns with SDR Sustainability Focus label

The ETF will track the underlying WisdomTree Energy Transition Metals Commodity UCITS Index.

Through a partnership with data solutions firm Wood Mackenzie, the selection and weighting of the underlying metals will be based on a forward-looking rating system.

The metals are given an ‘intensity rating’, which combines the demand growth forecast for the metal over three years with a market balance rating that reflects whether the metal is under or over supplied. The portfolio then rebalances twice a year.

Nitesh Shah, head of commodities and macroeconomic research, Europe, at WisdomTree, said: “Metals will be crucial to advance the energy transition. Whether it is to power more electric vehicles or create solar panels, it’s hard to see a world where the development of energy transition technologies is not dependent on the supply of some key metals. However, the challenge is to ensure that the technologies needed to achieve the energy transition are produced at scale.

“The challenge for investors is to navigate through the dynamics of technology shifts, trade policies and sudden increases in metal supply. The expertise offered by our partnership with Wood Mackenzie and a methodology that incorporates both supply and demand drivers help the strategy remain highly adaptive to the evolving market.” 

The global commodity market faces an of challenges that could influence its volatility, such as new Trump presidency in the US, ongoing tensions in the Middle East, and natural disasters across the coasts of Mexico and North America.

However, there is also another factor that is probably the most underestimated one — the evolving economic deterioration of China. So why and how exactly is China influencing the commodities market, and what changes can we expect in the near future?

China’s economy has peaked

China has long been considered one of the biggest world economies, but today’s forecasts are not bright anymore — many analysts think the country’s economic peak already passed in 2021.

The main reasons behind this phenomenon is excess production capacity, a downturn in the housing market, and low consumer activity. All together, they will continue to put pressure on prices.

As a result, China’s consumer prices showed no growth in September, with a year-on-year increase of just 0.4%. Core inflation, excluding volatile energy and food prices, slipped to a modest 0.1%, marking a clear sign of a broader economic slowdown.

See also: Is China at a turning point, or will it disappoint yet again?

This also coincides with China’s cheap labour resources nearing exhaustion, an increase in youth unemployment, an ageing population, and may countries in Europe and the slowing down imports their imports of Chinese goods.

The Chinese government is working to manage these changes, yet the situation remains challenging. And without further stimulus, China risks falling into a prolonged period of deflation similar to Japan’s experience in the 1990s.

These incentives will most likely be further increased in order to avoid the Japanese scenario and provide a gradual slowdown in economic growth to about 3.5 to 4.5% per year over the next three to five years.

China’s economy drives commodity markets

Economic shifts in China have a direct impact on global commodities. The country remains the world’s largest importer of key resources such as oil, and any changes in its purchasing behaviour are reflected in global markets.

The volume of China’s oil imports amounts to 11 million barrels per day, which is only slightly below the level of September last year and corresponds to the average figures for the last months. Overall, import volumes remain stable.

However, the average price of imported oil in September decreased as worries about demand from China pressured market sentiment. The oil price has since surpassed $60 per barrel.

See also: Fairview’s Yearsley: China becomes ‘story of September’

As for energy, it remains one of the key components of the Chinese economy. Despite the aforementioned economic hurdles, China has executed strategic adjustments to its energy sector that may soften its economic landing. From 2022 to 2024, the country managed to cut energy costs per unit of GDP by 5–15%.

The decrease occurred due to a few reasons. The first is linked to cheaper purchased resources since China mainly imports resources from countries in difficult economic conditions and offers them discounts of up to 30% relative to market prices.

Secondly, the country has modernized its own energy system, which has increased its efficiency and lowered prices.

How should investors adjust their strategies?

Faced with the problems within the Chinese economy, investors should pay attention to new opportunities in other regions and sectors.

It is worth looking at American companies, especially in promising areas such as energy, artificial intelligence, robotics, and big data. They are likely to increase their output, which also opens up new investment opportunities.

Indian and Mexican companies that can replace Chinese manufacturers in global consumer markets may also be promising. These two countries are actively developing their production facilities and becoming key alternative production centres.

At the same time, it is important to monitor the large volume of natural resources that China exports and look for alternative suppliers. This will help prepare for possible restrictions on Chinese exports or the introduction of export duties.

Some investors are already moving away from Chinese assets and switching to more reliable instruments such as gold or US bonds, with foreign direct investment in China turning negative for the first time since 1998. 

When is an alternative not an alternative? To answer this, it’s worth starting by defining what exactly constitutes an alternative investment. The UK asset management industry is responsible for some £2trn of alternative assets versus some £11trn in mainstream assets. The very size of this universe reflects that fact that the alternatives label encapsulates a broad range of different asset types and approaches.

For many, a simple definition may be something that isn’t categorised as equity, fixed income or cash which are considered the traditional components of portfolio construction. I’ve covered multi-asset funds as a fund analyst for many years and in this context, I’ve seen many different genres of funds banded and labelled under the broad alternatives banner.

Asset classes grouped into alternatives buckets include, among others, private equity and debt, digital assets, infrastructure, real estate and commodities such as gold. Within the hedge fund/absolute return sector alone there are further strategies that might fit under the alternatives label with long/short equity funds, global macro funds and CTAs (i.e. trend-followers) being some of the most familiar. While digital assets are a newer kid on the block, regulators and lawmakers are beginning to facilitate their more widespread use.

The growth of alternative allocations in multi-asset portfolios has been an observable trend for many years now. Popularity grew during the lengthy low inflation era when traditional bonds offered little in the way of yield and carried the risk of capital loss for those worried about a shift in the interest rate regime. In this environment, alternatives were a natural diversifier. More latterly, despite a regime change and a more attractive bond market, alternatives have maintained their appeal in portfolios. 

See also: Square Mile’s Fund Selector: IA UK smaller companies funds to watch

A recent look at well-known private client benchmarks showed that currently the ARC balanced benchmark has an allocation to alternatives of approximately 30%. Many DFMs and MPS managers are represented here.  Within the PIMFA conservative allocation, around 17% was allocated to alternatives and a 10% allocation now appears to be commonplace in high-net-worth portfolios. However, at a headline level, it can be difficult to see what type of strategies constitute these allocations because of the breadth of the definition. 

What is key when defining an alternative is a consideration of different risk and reward outcomes. Indeed, this is what makes alternative investment funds and strategies so useful for long-term investors and their portfolios.  They should offer a different risk/reward profile to the traditional asset classes investors are more used to seeing in their portfolios, namely equities and bonds.

A well-managed allocation to alternatives can offer a low and even negative correlation to these other asset classes helping with overall portfolio diversification. As an example of a compelling portfolio diversifier, we would highlight the BlackRock European Absolute Alpha fund which holds a Square Mile AA rating. This is a long/short equity strategy which is managed with a low net market exposure and which aims to deliver a positive absolute return over a 12-month period regardless of market direction. 

Another fund worth mentioning is the Square Mile A-rated WS Ruffer Diversified Return fund. This fund also aims to provide positive returns in all market conditions over any 12-month period with an emphasis on preserving capital. It adopts a multi-asset approach and its holdings will typically include a blend of growth (mainly global equities) and defensive assets such as cash, conventional bonds, index-linked bonds, precious metals and derivatives. This deployment of derivatives to hedge directional market risks is a particular feature of this strategy.

Portfolio diversifiers such as these aim to deliver strong performance (in absolute or relative terms versus markets) particularly during stressed market conditions, when volatility is high or rising.  It is this key characteristic that makes such funds attractive when held in a portfolio.

See also: Square Mile removes Jupiter Global Value rating on Whitmore exit

Which alternative to pick matters to ensure that an allocation to such assets and funds does indeed offer diversification. For example, a highly correlated equity focused absolute return fund will do little to offset the downside of equities during a sell off. Attitude to liquidity, risk and complexity are also pertinent to the selection decisions. Gold and infrastructure are relatively simple to understand while the black box perception of CTAs and global macro funds are more complex and often less transparent. This doesn’t necessarily make them bad but a higher level of due diligence will be needed.  

In addition, those who also value non-financial objectives may find the broad church of alternatives appealing.  For example, private markets and real assets can be one of the most impactful ways of gaining exposure to sustainable or responsible investment themes. It is worth noting that, while many alternatives strategies have daily liquidity structures under the UCITs framework, others such as private markets may be less liquid, but can be invested through closed-ended vehicles.

It is therefore important that portfolio managers and fund analysts are on top of allocations to alternatives and understand with granularity as well as in totality, the risks and rewards that an allocation to these strategies are contributing to portfolios. Most importantly, it is key to ensure that they are fulfilling their job of diversification alongside traditional assets, stocks or funds that are held in the portfolio… otherwise an alternative may not end up being one.

From September 2021, new regional, sector and asset classes were created, such as Latin America, healthcare and infrastructure, as well as commodities and natural resources. Consequently, the specialist category was cleaned up and went from about 330 funds to the current 130. This was a welcome and necessary development.

A broad church

The specialist sector remains an exceptionally diverse ‘catch-all’ cohort that incorporates single-country funds, absolute return, sector funds, targeted return, fixed income, money market and commodities, among others. It is noteworthy that passive penetration, which is ubiquitous and growing rapidly elsewhere, is entirely absent here.

The IA sector classifications are rules based, and presided over by the sectors committee, who regularly review the definitions to ensure they remain relevant and to check that the constituent funds continue to meet the inclusion criteria.

In the case of the specialist sector the inclusion criteria set out by the IA is: funds that have an investment universe not accommodated by the mainstream sectors. Performance ranking of funds within the sector as a whole is inappropriate, given the diverse nature of its constituents.

To put this into sharper focus, and to illustrate the variety within the sector, mapping across the constituent funds leads to inclusion in upwards of 50 Lipper classification categories, including around 18 mixed asset funds with various objectives from aggressive to conservative, 14 bond/money market funds, 10 single country offerings, largely made up of Korean and Russian funds, nine emerging market equities, seven gold and precious metals products and four biotech funds, resulting in a very broad church.

While the specialist category is somewhat of a curate’s egg, it is home to significant investor assets. At the end of June, the unweighted average size of the funds was around £940m and total invested across the sector was £118.7bn, although the top 10 largest vehicles accounted for two-thirds or £78bn of the funds under management.

The sector is dominated by Allianz Income and Growth at over £38bn in size or around a third of the total assets within the sector.

At the opposite end of the spectrum there are 24 funds that are sub-£50m in size, accounting in aggregate for £510m of assets and with an average unweighted fund size of £21m.

Given the focus on niche and arguably less mainstream investment themes this tail of smaller funds is perhaps not surprising. The arguments for and against smaller funds are nuanced, though fixed costs can be a negative drag on a smaller pool of assets, and they may also be unappealing to larger investors that tend to avoid overly high ownership levels within funds.

Macro influence

Given the sheer breadth of strategies contained within this asset class, the macro environment has wildly differing effects on the performance of the various constituents.

A more benign interest rate environment might, for example, be a tailwind for the bond, infrastructure, stylistically growth-orientated or long-duration assets and a headwind for the short-term money market funds.

Meanwhile, higher inflation and firmer energy and commodities prices act as a fillip for those funds investing in precious metals, energy and wider resources.

Recent seismic changes in the geopolitical landscape (ie Russia/Ukraine) and the unwinding of low interest rates as higher inflationary pressures emerged, have showcased the magnitude, thematic range and diversity within the specialist sector and its potential appeal to investors.

The heterogeneous nature of this cohort is illustrated in the extreme divergence in volatility seen through the sector over the past three years. Those funds exposed to gold-related assets and emerging European assets have, not surprising, been subject to extremely elevated levels of volatility, in the order of two to three times the magnitude of what might be expected from broad global equities.

At the other end of the spectrum, money market, and some absolute return-type strategies have exhibited exceptionally low levels of volatility as measured via their three-year standard deviation.

The resultant constituent three-year performance also exhibits significant dispersion from the top-performing fund’s return of 83% to the worst performer at -64%, a difference of 147%. Comparing this with a more homogeneous category such as IA UK All Companies, the difference between the best- and worst-performing funds (+41 and -36%) is 77 percentage points.

Since the IA review in 2021, the specialist sector has shrunk in terms of number of funds but remains extremely heterogeneous which, as the IA itself states, limits the use of the specialist category as an effective comparator peer group.

Read David Holder’s funds to watch by assets under management, three-year performance and newcomers in September’s Portfolio Adviser magazine

The September expectations of a soft landing include the largest proportion of investors so far this year. Those predicting a hard landing have also slightly dropped off from August, now including 11% of those surveyed, down from 13%. This has fallen significantly from the same time last year, when 21% of investors anticipated a hard landing.

In addition, over half of investors believe there will not be a recession in the US within the next 18 months.

Michael Hartnett, investment strategist for Bank of America, said: “Macro pessimism was centred on China in the September Fund Manager Survey… China growth expectations fell to a record low with net 18% expecting a weaker Chinese economy (most in 3-year history).

“In contrast, US growth outlook improved slightly in September with net 51% expecting a weaker US economy next 12 months, down from net 56% in August.”

See also: Legal & General hires asset management CEO from PGIM

As market sentiment looks slightly more sunny, surveyed investors took a small chunk from cash investments, from an averaged 4.3% of assets under management to 4.2%. Yet, a net 11% of those surveyed say they remain overweight in cash. Investors also remain overweight in bonds, with September marking the largest overweight since December 2023, at net 11%.

The sentiment movements have swayed Bank of America to mark commodities as a contrarian market play. Currently, allocation to commodities sits at a seven-year low among those surveyed. In the last four months, allocation to commodities has dropped 24 percentage points.

September’s global survey included 206 respondents, with 36 CIOs, 93 portfolio managers, 64 asset allocators, strategists, and economists, and 13 uncategorised. Of the group, 91 ran mutual funds and 58 ran institutional funds, with the rest in hedge funds, proprietary trading desks, or others. The average investment time horizon sat at 7.3 months.

See also: BNP Paribas: Nine in 10 investors now familiar with thematic investing

The fund is also available on the Borsa Italiana and Börse Xetra exchanges and comes with a 0.49% management expense ratio.

WisdomTree European Natural Gas ETC seeks to track the performance of the BNP Paribas Rolling Futures W0 TZ Index, which is designed to pride exposure to gas traded on the Dutch Title Transfer Facility — the benchmark for European gas prices.

See also: UK inflation stays at 2.2% in August – but a rate cut still seems unlikely

Nitesh Shah, head of commodities & macroeconomic research, Europe, at WisdomTree, said: “The Russia-Ukraine war that started in 2022 profoundly changed the natural gas markets of Europe. Pipeline flows of natural gas from Russia to Western Europe, which used to be the main source of natural gas for the region, are now negligible.

“Western Europe is far more reliant on Norwegian pipeline flows and global liquified natural gas imports. As the European Union navigates an energy transition, it will still be reliant on natural gas. With that in mind, there will be periodic sharp increases in European natural gas prices as the fuel is used to make up shortfalls in renewables.

“The Dutch Title Transfer Facility is the most representative and liquid natural gas benchmark in Europe and thus the best tool for tactical exposure to these price jumps and for hedging purposes.”

Covid unleashed a unique combination of shocks to commodity markets, impacting both supply and demand simultaneously – to the point that almost five years later the sector has yet to fully recover.

Since then it has been a case of feast or famine for investors. Optimists have touted super-cycles as economies open up – only for new Covid variants, supply and demand issues and wider geopolitical concerns to all play a role in dampening the optimism.

This year has been a continuation of the uncertainty. A strong start to the year has since ebbed away as a slowdown in China’s economy has raised concerns about demand for oil, copper, and other commodities. There seems to be little light at the end of the tunnel for China’s commodity-producing sectors – property and infrastructure – while there are also fears the current slowdown in production in China bears strong resemblance to the crash in the economy in 2015-16.

Commodities, as represented by the S&P GSCI – a benchmark of 24 commodities in agriculture, energy and metals – were up 16% year-to-date by April 2024, but have since fallen back to just 1.8%. This compares to a return just shy of 12% for global equities.

But despite the short to mid-term confusion, the long-term trends remain as strong as ever. First and foremost, commodities have a number of mega-trend themes which rely on them. Think of the likes of electrification for renewable energy and infrastructure, while metals are needed to build data centres to continue to improve both our connectivity and AI growth.

See also: Is a bitcoin allocation a diversification ‘cheat code’?

From an investor perspective, commodities are a key diversifier to equities and bonds. Take 2022 as an example: in a challenging market where inflation and interest rates rose in most of the developed world, global equities fell 8%. By contrast, commodities rose over 40%.

But confidence remains at a premium. Research from Lazard found that as of January 2024, the global allocation to commodities stood at 1.7% of total portfolios. This is well below the 4-9% range that recent Bloomberg analysis – based on sharpe ratio, risk profiles and historic returns from April 2003 to March 2024 – believes is ideal. I find that interesting given the geopolitical uncertainty and some of the longer-term supply and demand challenges for many metals, which could result in price rises.

We have always tended to break the sector into four subclasses: energy, precious metals, industrial metals and agriculture.

Energy seems a logical starting point. Oil has been quite a weak bellwether for global demand. Traders and analysts have been overwhelmingly bearish on oil in the past few months, although there are longer-term concerns about shortages should production not increase, with the ESG push meaning fewer oil rigs have been drilled in recent years.

The more immediate backdrop to this is that geopolitical tensions continue to rise. Russia’s invasion of the Ukraine shows no signs of coming to an end, while recent tensions between Israel and Iran saw the oil price spike before settling down.

Shipping costs have also escalated due to the attacks in the Red Sea, forcing some of the world’s largest shipping companies to suspend routes and redirect their vessels. Going the long-way round clearly has time and cost implications. The hope is that oil will establish itself as a hedge against growing uncertainty.

See also: Is the landscape finally changing for commodities?

Gas prices spiked following the outbreak of war in Ukraine, as Russia supplied 40% of Europe’s natural gas. This has since dropped back due to the likes of mild winters and with expectations that gas storage will reach capacity in Europe by September this year.

Industrial metals are strongly tied to some of the long-term themes I discussed earlier. Copper has fallen back from its all-time high in May 2024. China is the biggest user of the metal, so its fortunes can often be tied to its economy.

Copper is essential for the likes of electrification, and long-term supply and demand metrics are very favourable. For example, research from S&P Global Market Intelligence projected that global refined copper demand will nearly double from 25 million MT in 2021 to about 49 million MT in 2035.

Nickel prices recovered from six-month lows recently, but remain firmly in a bear market, trading down more than 20% from highs reached only three months ago. Lithium prices continue to struggle amid the EV slowdown.

I do not want to spend too much time on gold – but structural demand forces have been very supportive for the yellow metal, from buyers in emerging markets, China and money managers. Ongoing geopolitical uncertainty and the start of rate cuts should be beneficial for the physical gold, which reached an all-time high in August 2024.

Gold miners have generally disappointed for a long time but have also started to pick up, with the hope that the cost to mine gold becomes cheaper as inflation falls. The price of silver also soared in the first half of 2024, hitting levels not seen in over a decade.

See also: Gold hits record high: Fund picks to play precious metals

Agriculture tailwinds are perhaps the clearest of them all. It is crucial to economic growth, accounting for 4% of global GDP. More importantly, the need is paramount, with predictions that over 600 million people will face hunger challenges by 2030. Plenty of packages are in place to improve agriculture across the globe.

A quick run-through of some of the underlying assets within commodities indicates just how diverse the outlook within the sector is over the short-to-medium term, but the longer-term tailwinds continue to underpin the global economy. It is also a diversifier to traditional asset classes.

Investors looking for exposure may want to consider the BlackRock World Mining trust, which offers exposure to mining and metals companies worldwide, or the TB Amati Strategic Metals fund, which has exposure to the equities of numerous precious and industrial metals. Those who prefer a specific mandate may like the Jupiter Gold and Silver fund.

However, Matthews’ chief investment officer Sean Taylor warned investors not to get ahead of themselves, reminding them that much uncertainty lies ahead for Latin America.

Its commodity-driven markets – which are reliant on supportive macro environments – may well perform better when interest rates decline, but they are falling from far higher levels.

The Federal Reserve paused rates at 5.5%, but in countries such as Mexico and Brazil, rates stand 10.75% and 10.5% respectively even after cuts from their central banks earlier this year.

Latin America’s dominance in the commodities space does have its appeals over the long-term – namely its critical role in major industries such as electric vehicles and wind and solar technology – but it will likely be impeded by political volatility in some of its key economies.

See also: Robeco adds three indices to its suite of climate-related products 

A new left-wing government came to power in Mexico this year and the Brazilian government intervened with state-owned enterprises, stoking concerns over the country’s tax reforms and fiscal controls.

The region’s appeals over the long-term may appear attractive – especially given its much lower valuations not only to global markets, but its own historical prices – but it may be too early to call just yet, according to Taylor.

“Latin American equities are cheap for a reason,” he said. “Many markets are grappling with potentially significant changes in their domestic, political landscapes and almost all of them will be affected, sentiment-wise, by the geopolitical noise generated in advance of the US election in November.

“It will be an uncertain and bumpy road in the coming months. Only when the global monetary environment starts to ease and the domestic and international political dust starts to settle, will the region’s economies and markets have an opportunity to perform at a meaningful level.

“We think this warrants an approach that is conservative in the near term but also positioned to leverage strengthening long-term growth trends.”

UK equity income funds have outperformed their global and technology peers during the three years since the beginning of the cost-of-living crisis, according to research from AJ Bell, although Indian equity, US and commodity funds found themselves at the top of the pack.

While IA Global and IA technology & Technology Innovation funds have achieved double-digit returns over three years in nominal terms, at 13.5% and 10.8% respectively, they have still lost investors money in real terms, at 5.6% and 7.8%.

UK equity income funds have achieved an average gain of 16% over the period. Despite this relative success, it has still not quite been enough to see a positive return in real terms, having fallen by 3.5%.  

Top of the performance chart for nominal and real returns over the last three years are Indian equity funds, with the IA Indian/Indian Subcontinent sector having returned 46.7%. In real terms, this amounts to 22.1% in total return terms.

Other sectors to have achieved positive total returns in real terms since the start of the cost-of-living crisis are IA North America, IA Commodity/Natural Resources and IA Global Equity Income, at a respective 3.5%, 3.2% and 0.5%.

Laith Khalaf, head of investment analysis at AJ Bell, said the “surprising” fact that UK equity income funds outperformed their global and tech counterparts could be because of their exposure to energy stocks, as these produce a significant proportion of UK dividends.

“This exposure has afforded some protection to investors during the inflationary crisis,” he said. “Indeed, the UK Equity Income sector has outperformed the broader UK All Companies sector by 10 percentage points over the last three years (the latter has returned 5.6% compared to 16.0% from the UK Equity Income sector). UK Equity Income funds tend to have a larger cap focus than UK All Companies funds, which prefer to go hunting in mid and small caps – areas which have performed well over the long term, but not the last three years.”

A large chunk of UK dividends emanate from the energy and banking sectors, and this exposure has afforded some protection to investors during the inflationary crisis.

It also means the UK has kept up with the global stockmarket over the last three years, exhibiting a 4.7% return in 2022.

“Both the global and domestic stockmarket have managed to stay ahead of inflation over the last three years, which given soaring price rises is no mean feat,” Khalaf said. “The FTSE 100 in particular has stood up well, and its performance is in line with the global stockmarket.

“That’s partly because the FTSE 100 contains a large dollop of oil and gas companies, which have benefitted from higher energy prices. On top of this, banks have seen their net interest margins rise as base rate has climbed. The FTSE 100 also has more ‘jam today’ stocks which prospered in the market rotation that took place when inflation started its ascent, eroding the value of more distant cashflows and the appeal of ‘jam tomorrow’ companies.”

Gold has hit record highs since the start of the year, but those who held gold mining companies on the assumption that they benefit from its surge have been disappointed. That is, until the last few weeks when share prices have surged. Have investors missed the rally, or is it just getting started?

The gold price has been on a tear, rising from below $2,000 per ounce in February to its current level of $2,300. Its strength has been fuelled by central bank buying, geopolitical unrest and growing risk aversion – all in spite of high yields on bonds (which typically send the gold price lower). 

However, gold mining equities have not followed suit. In 2023, the MSCI ACWI Select Gold Miners IMI Index rose just 13.9%, compared to 22.2% for the MSCI ACWI. There were concerns about the impact of inflation on the day-to-day running costs of mining companies, particularly the rising cost of labour and diesel fuel.

That all changed recently. Over the past three months, the Gold Miners index is up an astonishing 34.9% against a return of 3.9% from the broader index. Fund managers believe this rally might only just be getting started, with valuations for many companies still at relatively low levels, and the companies themselves in good health.

But it is not just gold miners – gold typically leads the way for other precious metals, such as platinum and silver. 

Consolidation across gold mining companies and the precious metals sector as a whole has also supported prices. In 2023, Newmont Corporation successfully acquire Australian-listed Newcrest Mining to create the world’s largest gold producer.

Likewise, Rio Tinto is in the process of bidding for Anglo American, which is the world’s largest producer of platinum – accounting for around 40% of world output – as well as being a major producer of diamonds, copper and nickel. Many fund managers believe there is more consolidation to come in the sector.

George Cheveley, manager on the Ninety One Global Gold fund, believes this strength can continue if the gold price remains in its current trading range.

“Equity valuations look compelling as cashflows appear set to jump after the latest rises,” he said. “In a rising price environment, the companies tend to outperform. While this did not happen in 2022 or 2023 due to inflationary pressures on costs and the overhang from the pandemic, we see signs of these abating.

“We are seeing a number of companies with good growth, which should also see lower production costs per ounce. So, improving costs and increased merger and acquisition activity should result in the equities of gold companies outperforming a rising gold price overall.”

Cheveley is encouraged by the recent moves in gold mining companies, which he believes are more in line with the performance in recent cycles.

See also: High net worth voters back Labour despite private school tax

The managers of the BlackRock World Mining trust also increased their exposure to gold producers in 2023 given the improved gold price outlook.

Co-manager Olivia Markham said: “We have maintained our strategy of focusing on high quality producers which have an attractive operating margin and solid production profile and resource base.

“Typically, gold royalty companies offer a higher quality and lower risk exposure to gold as they do not face operating and capital cost inflation.”

Gold miners are also drawing the interest of global fund managers. Alec Cutler, manager of the Orbis Global Balanced fund, holds around 6% of the portfolio in gold, with around 4% in gold mining shares, including Barrick Gold and Newmont. This also gives him some copper exposure.

“When you mine for gold, copper pops out and that looks like a good place to be for the longer-term,” Cutler said. “The miners have been weak because they’ve been whacked by inflation. Their costs were going up because of Covid restrictions, which hit productivity, but that’s reversing.

“Their second biggest cost is diesel fuel and the price of diesel fuel went up, but that’s reversing too. Now the price of gold and copper are marching higher, so these companies are seeing positive margins.” 

Ned Naylor-Leyland, manager of the Jupiter Gold & Silver fund, argues for the inclusion of some silver exposure as well. The silver price has outpaced the gold price since February, rising almost 40%.

He believes this may continue, stating: “Silver benefits from monetary and industrial demand, as well as being historically undervalued (still 45% below its high from 2011). Silver has a long track record of outperforming gold when there is increased flow and participation in the asset class.”

Mining companies have also been through an important sustainability transition. Mining can be a grubby business, and companies have had to make capital investments to improve their carbon and pollution metrics.

Cutler believes this spending is now largely behind them, while also creating higher barriers to entry for new mines. This is likely to limit supply.

A final point is that if precious metals companies start to see improving cash flow, they may look to return money to shareholders through dividends and buybacks, or to buy their peers. This could be supportive of share prices across the sector.

A rally from the gold mining companies is a normal response to a rise in the gold price, and it looks as if this is finally starting to happen. It is always possible that this nascent strength could be derailed by weakness in precious metals prices, though it is difficult to see a thawing of geopolitical tensions, or risk aversion disappearing in the short-term.

In the meantime, valuations still leave plenty of wiggle room for mining companies to make progress.

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However despite it’s appeal of being a genuine alternative asset class, and the price of gold recently hitting an all-time high, it remains a sector retail investors seem to wary of.

According to the IA, after flat inflows in 2023, in the first three months of the year the sector has witnessed net outflows of £120.5m, despite positive returns over one and three years. Indeed in 2022, when bonds and equities fell in tandem, funds in the IA Commodities and Natural Resources sector produced an average return of 18.8% according to FE Fundinfo.

So is it time to place more faith in both the sector and, within in this, is gold still the safe haven asset it is purported to be?

“We remain bullish on natural resources, driven by factors such as the ongoing energy transition, growing supply-demand imbalances, and the evolving dynamics of inflation,” said Ernst Knacke, head of research at Shard Capital. “The challenge, however, lies in accurately assessing the ‘fair value’ of these assets.”

Among the array of commodities to choose from, Knacke said he likes gold, not just because of its shiny appearance, but more so owing to the current supportive supply-demand dynamics and the “rather attractive” trend characteristics.

“It also provides us and our clients with capital preservation against severe, but inevitable, monetary devaluation, as well as a hedge against event risks,” he said.

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Outside of gold, Knacke noted that natural gas holds promise in the long run, however he added the price trends in natural gas markets have seemingly entered an “abyss” and highlights the risks in commodity markets.

“A ‘commodity’ we like, albeit by no means a true ‘natural resource’, is regulated carbon markets,” he said. “It should benefit from rising commodity prices and offer an avenue for a more sustainable investment solution. Regulated carbon markets are supported by secular supply-demand characteristics and improving liquidity.”

Having reached an all-time high of $2,350/oz in April, another asset allocator drawn to the appeal of gold is Iboss. Kate Townsend, investment analyst at the group, believes it remains a long-term diversifier against more traditional risk assets.

“The in-unison fall of bonds and equities in 2022 exemplified the need for diversifying assets in order to reduce volatility and ultimately protect capital,” she said. “In the more inflationary environment we currently exist in, other alternative assets such as property have been facing significant headwinds as yields and interest rates rise.

“While gold has historically struggled in these conditions it has, so far, fared well in the face of broader market uncertainty. Highlighting the need for diversification even among alternative assets.”

Iboss gains its exposure to gold through the Ninety One Global Gold fund, managed by George Cheveley.

“We have held the position since August 2019 and it is predominantly exposed to gold miners,” said Townsend. “Typically, miners outperform in a rising gold market and have done so in the most recent rally. As inflationary pressures show signs of abating this could be even more positive for miners as they begin to show an increase in production, growth and profit margin. It is worth noting that due to its relative volatility even a small position in gold miners can act as effective diversifier.”

One asset allocator less convinced by the case for gold is Bevan Blair, chief investment officer at One Four Nine Portfolio Management.

“We do not hold gold in our portfolios and it is unlikely we ever would,” said Blair. “Our asset allocation process attempts to forecast financial markets using cash flow analysis discounting at an appropriate rate, to produce an expected return over 10 years. Because gold has no cash flow we have considered alternative forecasting methodologies – but in the long run the forecasting abilities of these models are weak and it becomes a guessing game.”

“We therefore have a naïve expected return of 0% for gold, with a large volatility. While there is some diversification benefit from holding gold, in our view this normally isn’t enough to outweigh the fact that gold has a low expected return. Inclusion of gold in the portfolios would therefore be a punt on our behalf and that is not what we are trying to achieve for our clients.”

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Blair added that he also does not subscribe to the theory that gold can be used as a hedge against inflation.

“It may be true over the long term, but your time horizon on this is typically in centuries, not decades,” he said. “Gold can perform poorly in high-inflation environments, the 1980s being the perfect example. By all means, have some gold, but keep it in a safe and give it to your great-grandchildren.”

While Blair might not be convinced about gold being an inflation hedge, Chris Faulkner-MacDonagh, a global multi-asset portfolio manager at T Rowe Price, is more convinced on the case for commodity equities in general.

“Commodity equities play a role in a multi-asset portfolio, both as a source of returns and as protection against inflation, said Faulkner-MacDonagh. “Importantly, we prefer equities over commodity futures, as companies offer operational leverage and ease of access, providing better long-term returns.

“Like commodity futures, the equities of commodity producers have a very high response to unexpected inflation, outperforming the broad market by many multiples when inflation surges. As a result, investors need only take a small allocation from their overall equity exposure to achieve protection.

“With attractive valuations and sustained global uncertainty, investors need to take inflation as a serious risk and look for the best tools to protect portfolios.”

Michelle Butler, senior portfolio specialist for real assets and infrastructure at Cohen & Steers said she is bullish on the case for commodity and natural resources over the next 10 years.

“We believe the world is transitioning from an era of commodity abundance to one of undersupply, which may result in strong commodities and natural resource equities returns over the next decade,” said Butler. “Factors such as rising borrowing costs, decreased globalisation and elevated geopolitical risks may hamper commodity supply growth, contributing to a substantial improvement in returns compared to the prior decade.

“We expect returns in natural resource equities to exceed those of the broader global equity market over the next 10 years as the macroeconomic regime shift drives opportunities in real assets overall.”

This article was originally written for our sister publication, PA Adviser