From the desk of the CIO: What the gold and AI booms mean for investors
By Matt Wacher
Big market moves are becoming more common, with large gains in September carrying over into October.
This is true for shares, bonds, currencies and commodities, with gold rocketing this year up over 60%. This sharp price is the result of investors and central banks buying to diversify their assets away from US dollars. We’re seeing these moves because of concerns around the high level of debt, deficits and the independence of the US Federal Reserve.
One often overlooked factor is the very small size of gold as an asset class, which can lead to exaggerated price moves in both directions when sentiment changes rapidly. As with all financial assets, huge price rises and frenzied universal popularity don’t bode well for future returns, so investors should take note of the large falls in price that followed comparable episodes in the past.
In equity markets, it’s Artificial Intelligence that is still the key driver of market returns, share prices surging for so-called ‘hyper scalars’, companies that provide global scale data centres. Here, there are clear signs of a change in fundamentals that echo those of the last great IT boom in the late 1990s. Two of note are (1) a step change in capital spending and (2) tie-ups between major players.
Spending on capital expenditure has spiked for firms that had previously sustained high rates of profitable growth without the need to invest a lot of capital. This made them highly profitable and set them apart from more traditional industries, like manufacturing and real estate, that need lots of capital to expand. But now these are spending up large on data centres, servers, advanced computer chips and even nuclear power generation. For example, this year $353bn USD of AI-related capex has been committed by just 4 companies: Alphabet; Amazon; Meta and Microsoft. The investment is of course expected to be profitable but it’s uncertain how long it will take to pay off and what the eventual return on capital will be. Right now, it is very low.
The mammoth scale of investment needed has prompted a coming together of many companies to fund and make what is required. Non-profit entity Open-AI of ChatGPT fame has been at the forefront of dealmaking, buying custom AI chips from multiple chipmakers, and Nvidia committing to invest up to $100bn in it. Microsoft is a key backer of Open AI. While these companies were already connected as suppliers to each other or joint venture partners, this extra step ties their fortunes ever more closely together and creates the conditions for a rise in the correlation of their returns. As these businesses are already large parts of stockmarket indices, investor portfolios are becoming less diversified and more concentrated. A similar dynamic existed during the late 1990s when telecom, media and IT companies became highly correlated.
So what does this mean for investors? Of course, productive investment that pays off will make these companies more valuable, but they are already priced for this. The real lesson from prior technology booms is that they are bullish for high quality bonds because they put downward pressure on global prices. AI is expected to have similar benefits in terms of reducing the costs associated with providing goods and services and improving their quality.
In our portfolios, our focus remains on opportunities and diversifiers that are not driven by the AI boom or still remain out of favour including healthcare, US small companies, UK equities, emerging markets and some traditional consumer names.
