Gold: Volatile in the Short Term, Good for the Long Term
Friday, Sep 25, 2020
We are currently witnessing a correction in asset prices driven by global risk aversion and a strengthening US dollar. Unrelenting pandemic and geo-political tensions are casting a shadow on global economic recovery. Investors are getting nervous and we are seeing a sell-off in assets across the board, including gold. This seems to be similar to what happened in March when gold surprised market participants by temporarily moving in tandem with equities, as investors scrambled to sell what is liquid and profitable.
Yes, gold's popularity might have waned a bit as of now. Analysts and money managers may be proclaiming an end to the bull market. But gold investors with long-term horizons have more than enough reason to remain calm and confident. That's because the macroeconomic tailwinds that instigated the bull market in gold in the first place, are very much intact, and are expected to stay that way for the next few years, so that gold plays a risk-reducing, return-enhancing role for their portfolio.
We are talking about the ultra-low interest rate environment, soaring deficits & unsustainable debts, rising inflation and debasement of currencies.
The coronavirus pandemic is expected to impact economic activity for years to come, with the economic outlook looking grim. This tells us that monetary and fiscal policies around the world will continue to be accommodative to boost GDP growth.
Massive and unserviceable mountains of government debt are piling up throughout the developed world as governments roll out stimulus measures in a bid to boost pandemic-hit economies. This combined with sluggish economic growth is making central banks around the world print unprecedented amounts of dollars and other currency in order to fund the government’s bills and try and stimulate the economy. This monetary inflation and the resulting price inflation will result in debasement of the dollar and other currencies, weakening their purchasing power. Gold, a stable form of money with potential to store value over long time periods, will become a preferred choice for investors and savers seeking wealth preservation. Gold can act as a counterweight to paper money which is fast diminishing its credibility as a store of value.
In addition, such unprecedented expansion of balance sheets could potentially lead to defaults and debt crises in the long run, especially in the weaker economies. In this case too, gold would be a big beneficiary. As of now, record high debt levels by the United States government which are set to reach 120% of GDP by the end of 2020 are becoming a cause for concern and threatening the dollar’s reign as a reserve currency. Gold, which is priced in dollars, is set to benefit from this sliding confidence in the dollar.
As part of the accommodative policy to boost economic growth, bond yields and interest rates are bound to stay low in nominal terms and negative in real terms for the foreseeable future - the Federal Reserve has committed to keeping rates near zero till 2023. Such low yields will limit bond markets’ ability to act as a hedge against equity price volatility and at the same time minimize the opportunity cost of holding zero-yielding gold. This trend will be bullish for the yellow metal as it becomes a preferred asset for portfolio diversification.
In essence, we do not believe that there has been any material change in fundamentals that have led to the Bull Run in gold. The decline in gold prices seems to be a temporary corrective, consolidative phase and we aren't surprised. The Bull Run in gold from 2000 to 2012 had 7 reasonable sized corrections and so could this Bull Run.
Cut to now. As tremendous uncertainty persists in the global markets, gold’s near-term movement, like other asset classes, won't be linear in direction. But it is important to view this volatility as an opportunity, not as a risk.
This investor understands equities are higher risk instruments compared to fixed income instruments like Bonds, but both carry risks. Since mutual funds are vehicles with these underlying assets, they too carry that risk.
With the recent fall in prices, gold's risk-reward proposition now looks even more alluring. It is indeed a good time to actually be buying the metal, not avoiding it.
We suggest that investors should invest during the dips and build their allocation to the metal. Gold has given 26% returns as on September 24th, in this calendar year to those who have has invested in it. Because the lingering macroeconomic uncertainties and systemic vulnerabilities as laid out above are going to ensure that gold will remain a preferred strategic asset for years to come, powering its price to new highs.
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