Published: October 4th, 2020
Gold may have its detractors, but the turmoil of 2020 has encouraged those who think the greenback and other ‘stable’ fiat currencies are headed for debasement.
Bullish gold buyers are driving prices steadily upward as the precious metal becomes a first-rate beneficiary of the Fed’s new willingness to shock the financial system back to life after COVID-19.
Fed head Jerome Powell dug-in on its stance in August, saying the world’s leading central bank had dropped its longstanding approach, whereby it would pre-emptively take steps to stave off inflation.
Pinning interest rates close to zero and permitting inflation to run sizzling had buyers anticipating cash losses after inflation on purchases of 10-year U.S. Treasuries. In that environment, investors began buying up the treasured yellow metal to shield themselves from the expected volatility across currency, commodity, and equity markets.
Gold analysts at State Avenue International said this week that gold could draw on hundreds of years of performance history as a safe haven, meaning it continues to be an attractive option when disruption upends traditional markets.
That’s pushed the value of gold futures up nearly 25 per cent since the start of the year.
In the 1908s the Fed aggressively raised interest rates to keep inflation in check. That boosted bond yields and meant gold paid provided few advantages beyond portfolio diversification. Now with bond yields at near zero, the precious metal is back in favour.
Gold crossed the $2,000 per-troy-ounce barrier for the first time this quarter, a peak that began in 2015 but hockey-sticked upward after Covid-19 arrived in the Spring. Its rise continues and shows no signs of slowing.
To hits its all-time high of $2,800, last achieved in the early 1908s, it will need to rise another 43 per cent.
For many market watchers, since it primarily offers investors an alternative to the dollar, what gold’s sharp ascent indicates is fear.
Bullion has only been more expensive twice: in 2011, when the potential for a eurozone break up was in the offing, and a U.S. government stand-off over the U.S. debt ceiling both drove demand. Its skyrocketing value in the 1980s happened after the Islamic revolution in Iran when concerns about oil prices created inflation worries and fear that the value of the greenback would be eroded.
Sliding dollar yields have given dollar-denominated bullion a boost. The Dow Jones Greenback Index, which tracks the dollar against a weighted basket of national currencies, fell for five straight months through August. Although dollar yields have strengthened, gold bulls say negative pressure on the greenback is bound to rise, especially when state supports for the economy during lockdown dry-up in late October.
The dollars’ role as the world’s reserve currency is now being called into question by many in the currency market, including analysts at Goldman Sachs Group. In a July analyst note, they said that despite gold’s position as the forex asset of last resort, with interest rates at record lows, investors have to look again at bullion’s potential for gains, as well as a way to minimise losses.
Bond yields have burnished bullion’s reputation in other ways. Since bond yields have an inverse relationship to transaction costs, the fact they’re so low means U.S. treasuries are unusually expensive. Many cash managers say bonds won’t offer much headroom if equities and other instruments take a tumble.
Currency strategists at PineBridge Investments have said they expect monetary repression to arrive in both the U.S. and U.K. this year, which will have the effect of ‘supercharging’ gold’s value.
Gold has already performed well as a way to smooth out returns in recent years, a trend that’s pushing many cash managers to recommend that clients think seriously about bullion as a counterweight to sinking shares. And yet …
On paper at least, gold isn’t a terribly good investment. It doesn’t deliver interest and won’t ever pay a dividend. Gold buyers only see a return if other investors rate the yellow metal more highly tomorrow than they did yesterday.
For a safe haven that protects capital in disrupted times, it is almost entirely speculative. Apart from ‘gold plated’ vanity objects and very discreet industrial applications, most of the permanent demand for gold comes from jewellery. Its recent rise in value reflects the sad fact that many alternative options are worse, rather than any built-in merits.
For gold sceptics like Simon Marsden of Bullion Reserve, the arguments in favour of bullion don’t hold much water.
Speaking to journalists this week he pointed out that this year’s surge in gold prices dovetailed with a surge in speculative buying and selling in derivatives, alongside a jump in the shares of tech firms with little or no history of creating income. For these investors, gold's upward surge is side-effect of aggressive risk-taking spurred by over-generous financial stimulus.
Buyers may also come to see more value and reduced transaction costs by looking to exchange-traded funds rather than taking direct possession of gold bars.
Exchange-traded funds backed by gold, which permit buyers to guess on bullion costs rather than build up an inventory, are also growing in popularity. As of August, buyers have poured cash into these funds for the ninth straight month. According to Bloomberg, ETFs now account for a virtual horde of gold equivalent to 3,800 metric tons, more than any single central bank except for the Fed.
As much as investors would like to see it, there’s no incontrovertible proof that gold’s reputation as a dependable store of value will be enough to enable investors to hedge against inflation.
Gold’s value has needed centuries to prove itself in the past. Today’s investors are unlikely to be willing to wait that long.