When the lights go down in the California town
People are in for the evening
I jump into my car and I throw in my guitar
My heartbeat in time with my breathing
Driving over Kanan, singing to my soul
There’s people out there turning music into gold
– John Stewart & Stevie Nicks
With the US gold price hovering just below the $2,000/oz level, it is timely to take a look at its recent good performance and discuss what could be in store for the yellow metal over the next 18 months. History has held gold as the ultimate store of value for many decades. The recent performance has seen gold post a 32% return since the 1st October 2019 ($1,482/oz to $1,960/oz) which has been strong relative to other asset classes.
The performance though was not exactly a straight line with gold suffering like pretty much every asset class did in the COVID-19 induced volatility in March 2020.
The impact of COVID-19 especially in the US where it has been the most affected economy inside the G10, which has seen huge contraction in Global GDP growth has created an unprecedented response from global central banks. The monetary and fiscal stimulus in terms of announcements thus far is circa $20 trillion ($8 Trillion of monetary stimulus and $12 Trillion of fiscal stimulus) which is around 20% of Global GDP. This response has been astonishing. The concern here is that the rush by central banks to expand their balance sheets with the objective of providing a back stop to asset prices and consumer prices could result in a lot of risks being socialised.
As economic output falls and fiscal outlays surge, and central bank balance sheets expand, fiat currencies could come under pressure. Should this become apparent, investors will again turn to gold.
There are headwinds of course to this theme, with equity markets stabilising and lower jewellery demand from India and China all reducing investor demand for gold. Gold has been traditionally a hedge against inflation, and in that regard recent comments made by Jerome Powel of the US Federal Reserve are poignant. Expect interest rates to stay at zero for the next 3 years or until inflation averages 2% per annum. There seems little doubt that there is little upside risk to inflation when central banks around the world are trying to massage inflation up.
The huge social upheaval over the past six months has created significant demand for gold or its proxy in the form of ETF’s. Gold ETF inflows have hit record levels in recent months causing a surge in the purchase of gold futures as the hedge by market makers. The spread between physical gold and the futures price has blown out of late as the mechanism of physical delivery has been affected by COVID-19. Typically LME (London Metals Exchange) acts as a backstop to the CME (Chicago Mercantile Exchange) for physical delivery as the inventory held in the CME is well below the open interest.
Despite the strong performance of gold, the positioning of the momentum-based CTA’s (Commodity Trading Accounts) has been relatively weak. According to Bank of America, CTA’s positioning in gold peaked in January at 56% of their maximum length and has since fallen to 5.7%. This could change, due to moves in other major and physical assets as the gold volatility is a function of real interest rates, $USD, commodities and risk.
Central bank buying of gold has also played its part especially those from emerging markets. Russia, China and India have opted to increase their holdings in gold over the past 5 years to diversify away from G-10 sovereign bonds. As fiscal spending plans across developed economies hit record highs in terms of percentage of GDP, the demand of emerging economies for developed market sovereign bonds could switch in favour of gold.
How this all pans out over the next 18 months will be very interesting to watch. The contraction in GDP is already starting to moderate with economic recoveries showing green shoots with falls in GDP being less than forecast. Developments on the COVID-19 front with vaccine being positive, or second wave infections (negative) all still unknown, the ability for governments to kickstart economies through massive stimulus must work. Should this fail, increased volatility could again cause investors to seek out gold and according the Bank of America could push the gold price to the $3000/oz level over 18 months.
The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.