Posted On Tuesday, Aug 11, 2020
From a worsening pandemic to a slow economic recovery, the global economic picture is still far from clear, and strong investment demand for gold reflects this. Expectations of further relief money, low interest rates and US-China tensions are other factors driving investors to the yellow metal.
Gold prices took a big leap in July, increasing by 11% in US-dollar terms. Prices ended the month at US$1,974/oz, a level not seen since the 2011 high of US$1,921/oz.
As gold moves from strength to strength, investors are asking the question - Is it a good time to invest in gold? We think it is, and here's why.
A second wave of infections is being witnessed again in Japan, Australia, South Korea and Vietnam. At the same time, cases continue to increase in USA, Russia and India. This could lead to further lockdowns.
The more time it takes to end the Lockdown, the slower the economic recovery will be. With this background, it is hard to imagine a situation where central banks will change their accommodative stance any time soon.
To add to the mess, the gap between the real economy and stimulus package-driven financial markets is increasing the possibility of a market crash. Financial markets seems to be volatile until a vaccine is developed. With all the above factors, gold is proving to be a good portfolio diversifier and an important asset in these uncertain times.
The dollar has been dropping in a big way. The currency lost 4.4% in July and hit a two year low. This dollar weakness is due to a host of factors - United States' failure to control the virus outbreaks and investor worries over its economic recovery being the major ones.
With infections rising, local economies are shutting again, breaking hopes of V-shaped recovery. At least, the US seems to be falling behind as far as its management of the pandemic situation is concerned vis-a'-vis other countries in Europe and therefore will have to do more to support the economy.
The US economy contracted by around 33% y-o-y during the April-June quarter. U.S. consumer confidence too plunged to 92.6 in July from 98.3 in the previous month as impact of infection increased. Investors are thus doubting the traditional view that U.S. economic growth and investment returns from the dollar would be higher than other countries going forward. Adding to investor worries, the U.S. government is struggling to finalize the next economic package, without which the economy may worsen further in the months ahead.
With this background, investors were looking to the Federal Reserve to reassure that it will do whatever it takes to support growth, and it did just that. The dollar has been falling on expectations that the central bank will continue its existing monetary policy for years to come. There was also talk about the central bank tolerating higher inflation going ahead. This would lead to lower/negative real yields and sink the currency further as more relief measures are announced.
In addition, high debt levels by the United States government are set to reach 120% of GDP by the end of 2020. This is challenging the dollar's status as a reserve currency.
Gold being a relatively risk-free asset of last resort, will benefit from an economic slowdown in the US, sharp increase in inflation, debasing of the dollar and low/negative real US interest rates. If the U.S were to adopt negative nominal rates as they implement the Modern Monetary Theory, this could just speed up the decline in dollar's value. Gold which usually moves in an opposite direction to the dollar, will continue to benefit with a fall in the value of the dollar, as it is currently.
Additionally, the EU's surprising move to issue common debt on behalf of all its members is a move showing the EU's unity and could increase the faith in the euro. This could weaken the position of the U.S. dollar as the only "global currency". This too should support gold.
Another factor that weighed on the currency was tensions between the United States and China which got worse in the month after embassies were closed. Both countries are disagreeing on almost every front. As the relationship between the two further weakens, the risk of a military clash is growing. Such fears again hurt the dollar and were supportive for the yellow metal.
Even though Gold ETFs have received record inflows in 2020, greater than any previous full year, gold remains an under owned asset. Market share of Gold ETFs compared to all ETF assets jumped from 3% to 8% in the years after the Global Financial Crisis before falling to 1% levels in the following years. The current figure stands at 3% indicating great possibility for Gold ETF asset increase going forward.
Another indicator that the yellow metal is under owned is that global portfolio allocation to gold stands at only 2.5%, a figure far from the ideal allocation of 10-15%. This means that even a small increase in portfolio allocation to the asset class could translate into price increase for gold in the time to come.
In the world before impact of Covid-19, bonds and equities usually moved in opposite directions. But this might not be true in the future. This makes it important to revisit the investment mantra: the use of bonds as a diversification tool against equities.
Central banks continued to remain accommodative for six years following the Global financial crisis of 2008. The impact of current crisis is many times more severe than that. This tells us that monetary and fiscal policies around the world will continue to be loose to boost GDP growth for the next few years.
Already, as per the IMF, global public debt is expected to exceed 100% of GDP in 2020-21, up from 80% last year. And the average fiscal deficit is expected to touch 14% of GDP in 2020, up from 4% last year. This is a big rise, and there is more coming. Low interest costs are the only way to manage these debt levels that have grown too large to be managed.
Thus, bond yields and short-term interest rates will stay low for the near future. In addition, the chance for bond price increase isn't much since rates are at all-time lows already. Both these things are expected to reduce bond returns and increase gold's role in the portfolio.
Gold is trading in new territory. But the long-term outlook is supportive for the yellow metal. With governments struggling with rising deficits and debt, make a strategic allocation to gold because it's acts as a diversifier to paper money which is continuing to lose trust as a store of value. Any price corrections will be a good buying opportunity to build up your 10-15% allocation.
Source: Bloomberg, World Gold Council
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