All That Glitters?

While not technically a sector, gold has become a hot investment topic over the past several years. And with the price per ounce recently breaching $1,600 as investors look for a potential safe-haven in the light of debt concerns in the US and abroad, we’ve seen our clients wonder whether they too should add some of the precious metal to their portfolios.

We don't claim to be experts in the proper valuation of gold and have no official position on where the price may go from here. Gold has no earnings, cash flow, or business prospects, is not the standard on which any major currency is based, is not used for commercial transactions, and has a limited industrial use—making it extremely difficult to arrive at what would be considered a 'fair' value. And that is one of the reasons why we caution clients against getting very heavily invested in gold. And while it is often thought of as a good hedge against inflation, stocks have actually posted better returns during inflationary periods. As a final point, up until the last five years, gold's returns have been relatively anemic. It was trading at $400 per ounce in the early 1980's and by 2004 was still trading around that same mark — 20 years of virtually no movement — certainly not keeping up with inflation.

Of course over the last five years, we have seen the price of gold explode, bringing more investors to the party than ever before. Again, we have no official position, but do suggest investors use extreme caution when looking at gold as a potential investment. You can never know a bubble until after it bursts, but the hyperbolic move in prices warrants at least a thought that one may exist. For investors who insist on being exposed to gold, we suggest a very minimal holding, with the vast majority, if not all, of investment dollars being allocated to more traditional instruments such as stocks, bonds, and cash.

In order to help facilitate that process, for those investors who are more tactically inclined, we provide views on sectors for the next several months. Within a diversified equity portfolio, an investor may want to make some minor adjustments to sector allocation in order to potentially take advantage of market developments. We recently made several changes to our recommendations in order to be in a better position to possibly take advantage of what we believe will be a second-half resurgence.
 
In order to take the first steps toward a more cyclical view, we upgraded our views on consumer discretionary and materials back to marketperform, We have moved consumer discretionary back to marketperform because we believe the soft patch in the economy we have seen as of late is beginning to dissipate and the economic growth will pick up in the second half. As such, we believe consumer spending, which has stayed relatively resilient, will start to improve. Although disappointing so far, we believe that job growth will start to accelerate, helping confidence while also putting more money into consumers' pockets. The materials sector has rebounded to marketperform as well because signs are beginning to emerge that the recent moderation in economic growth was only temporary, and that we could see an acceleration of activity in the second half of the year.

We have also moved the industrials sector to outperform as we believe we'll start to see a renewed acceleration in economic activity in the second half of the year, which should benefit the industrials sector as businesses look to invest in their equipment and put large cash balances to work . At the same time, we downgraded our view of the health care sector to marketperform, and moved consumer staples and utilities to underperform. The health care sector seems to be among the groups that have recently traded most closely with the shifting view of the overall economy. Investors have flocked to the sector when fears were rising of a potential return to recession, but have started to drift away again as recent data has started to solidify at levels well above those that would indicate such a dire outcome. As for the utilities sector,  we believe we're in the process of investors upgrading their economic assessments and therefore moved our view of the utilities sector down to underperform from marketperform.
We also continue to hold a marketperform rating on energy, financials and telecoms while information technology remains at outperform. Our recommendations can and do change quickly at times as we continually monitor economic progress and specific factors influencing individual sectors.

Kully Samra is UK branch director at Charles Schwab.

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