If you’ve been following the headlines, you would have seen that gold has been on a rally of some kind. If you’re like us, you may have wondered what exactly drove this surge? To put it simply, it points to economic uncertainty.
Gold price has risen approximately 30% this year already.
Say you bought THB100k worth of gold in January and held onto it, then sold it this month, you would have roughly ended up with THB130k in just 7 months. That’s not bad at all.
So, gold price is tied to multiple things, but historically when the economy is heading towards uncharted territories, gold typically goes up. This is because investors see gold as a safe haven when they wish to hedge their bets against a falling dollar and instability in financial markets.
Gold historically has also moved in the opposite direction of the interest rate and the dollar.
In Context: The US Dollar
The US dollar has shown signs of weakening, and this started as early as mid 2019 when the US Central Bank (Fed) signaled a cut of interest rate because of uncertainty caused by US’s trade battle with China. Then, market uncertainty was further cemented by the Covid-19 outbreak, which then led the Fed to unleash a series of stimulus to aid the economy and to offset some of the initial shock at the height of the outbreak. This, combined with the US government’s stimulus measures, from the checks, PPP loans and unemployment relief further increases government debt.
Knowing this, it further drives investors to seek out gold as a hedge against inflation (generally rising prices of goods and services within a particular economy), which can be caused by mounting debt. Higher inflation can make the real interest rates down to negative. A real interest rate is one that neglects an effect of inflation
The US dollar index is typically a benchmark of value against a basket of other currencies, from the Euro to the Japanese Yen. The Yen has fallen 8% in the past 4 months.
Why has the gold price suddenly surged again?
Okay. So right now, Five year Treasuries are now yielding -1.16% once the effects of inflation is stripped out, its lowest close in seven years. A negative interest rate implies that if you deposit money into a bank for a period of time, your money will actually be less valuable when you make a withdrawal. This has led people to turn to gold, as a “Store of Value” instead of a regular savings account at a bank.
Having said that though, after adjusted inflation, the price of gold is still below its peak back in 2011, and far below an all time high from 1980.
The main driver behind gold’s latest rally “has been the real rates that continue to plummet and don’t show signs of easing anytime soon,” said Edward Moya, a senior market analyst at Oanda Corp to Bloomberg.
“When interest rates are zero or near zero, then gold is an attractive medium to have because you don’t have to worry about not getting interest on your gold,” said Mark Mobius, co-founder at Mobius Capital Partners.
JP Morgan was bullish, and now remains on a more neutral ground; Gold “will likely see one last hurrah before prices turn lower into year-end,” JPMorgan analysts said in a report. The bank has now turned neutral on gold and added that the current price might be close to a peak.
Watching the Fed’s reaction
It’s advisable to monitor the Fed’s actions in this case, as they are the ones with power in determining interest rates.
From Dec 2008 to June 2011, the Fed bought $2.3 trillion of debt and lowered interest rates, sending gold price to its peak in 2011. As the US government issued trillions of dollars worth of stimulus during the height of the pandemic, it will undoubtedly affect inflation in the future.
Bank of America has forecasted that gold could go up to $2,000 over the next 18 months.
“As economic output contracts sharply, fiscal outlays surge, and central bank balance sheets double, fiat currencies could come under pressure,” argued authors Michael Widmer and Francisco Blanch. “Investors will aim for gold.”
Impact of Covid-19 on gold’s supply chain
Today, gold moves from producers to refineries and then into the gold market. There are 3 traditional ways gold travels across the world: commercial flights, cargo planes, chartered airlines. Now, because of the global pandemic, the number of commercial flights which are the cheapest way to move gold went down by 75%, which forces transportation fees to be more expensive on top of an already high asset class.
Luckily though, we’re living in a digital age where you can bypass some of these real world restrictions. Xbullion.io for example, which was built to solve the physical storage problem by bringing liquidity to the asset class. By digitizing the asset registry, these platforms make it more flexible and convenient to transact, trade at any point of the day.
The Key Takeaway
The key takeaway? Understand the context behind gold price movements, and the correlation it has with markets as a “store of value”.
- Don’t rely on displayed interest rates when deciding to deposit money in a bank, you must remember to factor in inflation so that you will know the “real” interest rate.
- Diversify your assets and store of value. Do not go all-in on gold even if you’re bullish, it can also drop on certain days.
- Why not look for other alternatives? The digital assets market has been having a wild ride itself as more institution money is going into such alternative financial assets. Even PayPal, whose’ core business is facilitating money transfers, is getting into digital assets.
- Just look at it like this, Ethereum price went up by 50% and Bitcoin price went up by 25% in the past 2 weeks. Again, these are volatile times, don’t invest with more than you’re comfortable with or can afford to lose.