Where do we gold from here
The extensive global monetary and fiscal stimulus measures that have been rolled out in response to the crisis, especially in the US, make any return to ‘normal’ financial conditions even more challenging than in the aftermath of the 2008 financial crisis. With elevated uncertainty around the potential unintended consequences of these global easing packages, the attractiveness of gold is likely to rise further, given the yellow metal’s lack of credit risk and proven track record as a store of value.
Furthermore, gold’s relative drawback of not bearing any yield has been heavily reduced following the recent round of monetary policy easing around the world. The large increase in the pile of debt in the economy will likely force major central banks to remain accommodative in years to come, with policy rates potentially remaining at very low levels for an extended period of time. With such low yields, even modest inflationary pressure could prove painful for bond holders if real rates stay in negative territory.
With low opportunity costs and relative invulnerability to any future rise in inflation, gold is likely to attract more interest from investors.
However, gold’s rise since last year is mostly due to the decline in US 10-year real rates, which moved from 1.1% in November 2018 (when the gold price was around USD1200 per troy ounce) to -0.4% in early May 2020. With the US Federal Reserve’s limited appetite for negative rates and our scenario of tame inflationary pressure over the next few years, US real rates may struggle to fall much lower than their current levels.
“The attractiveness of gold is likely to rise further, given the yellow metal’s lack of credit risk and proven track record as a store of value.”
Indeed, while past episodes of quantitative easing in the US did lead to a decline in US real rates, this was only due to the fall of nominal rates as inflation expectations remained stable. However, as the Federal Reserve is unlikely to welcome an inverted rate curve, the downside potential of nominal rates seems limited. At the same time, the collapse in economic growth and our scenario of a slow recovery favours modest inflationary pressure in the next few years as the economy operates at below-trend levels. Coupled with the collapse in oil prices, US real rates may not play an active factor in a much higher gold price.
However, what could support the gold price are growing concerns about fiat currencies. Indeed, while inflation in the price of goods was absent in the wake of the extensive monetary and fiscal stimulus of 2008, inflation in financial assets did occur, as evidenced by the impressive US equity bull trend that followed. The flood of liquidity is likely to further boost asset prices quoted in fiat currencies, or in other words, lead to an erosion in value of fiat currencies relative to financial assets. As such, gold should benefit from a global depreciation of fiat currencies. Furthermore, this trend could even accelerate should some governments push for weaker currencies if and when their economies weaken after the recovery phase, because of potentially limited room for additional fiscal or monetary easing measures. And while defensive currencies such as the Swiss franc and the Japanese yen tend to be affected by many of the same investment factors as gold, they are unlikely to prove as good as gold as a store of value.
Because gold is priced in US dollars, the trend of the American currency is always predominant. We are doubtful that the dollar will be able to sustain its broad appreciating trend since 2011, given the complete erosion of its interest rate advantage and long-term fundamental overvaluation. Overall, we see scope for some depreciation in the US dollar in the next few years, which should prove supportive of the gold price.
“Gold should benefit from a global depreciation of fiat currencies.”
We see investment demand as the main driver of the price of gold, despite its accounting for less than 30% of total gold demand. However, we should not forget that jewellery demand, accounting for roughly half of total gold demand, may remain weak in the next months. Indeed, lower global income due to economic contraction and a high gold price are definitively not supportive of jewellery demand. Nevertheless, as shown in the first three month of this year, a collapse in jewellery demand is not an issue if investment demand is strong. While the likely reduced affordability of gold in the next few years suggests subdued jewellery demand, we see investment demand as strong enough to lift the gold price. However, this may lead to higher volatility should investment temporary falter as the usual support provided by jewellery demand has weakened.
In a similar vein, official demand will likely fall this year following the Bank of Russia’s suspension of gold purchases from April. Other strong buyers of gold, such as Turkey and India, may also limit their commitment due to turbulence in their respective financial markets. However, we see this weakness as temporary. Indeed, reserve managers in developing countries are likely to further accumulate the yellow metal because of its diversification role relative to the US dollar, its lack of credit risk and its proven efficiency as a store of value.
Although we acknowledge that gold has already had a good run over the past quarters and is not immune to potential price corrections, investment demand is likely to remain strong in the next few years. Indeed, gold bears no credit risk, is an effective store of value — especially in periods of high inflation — and is broadly negatively correlated to the US dollar. As such, demand for such an insurance in light of the potential unintended consequences of global massive monetary and fiscal expansion is unlikely to falter soon.