Glistening gold

15 September 2020

6 minute read

Can a record high price, surging public debt levels, COVID-19 infection risks and low rates sustain gold’s appeal?

Key points:

  1. Gold held in exchange traded funds has surged by 31% this year, as investors flock to safe-haven assets, amid the pandemic
  2. While equities have resumed a bull market at record speed, sentiment looks fragile, probably boding well for the precious metal
  3. Depressed real rates and an expanding pool of negative-yielding bonds are likely to bolster the commodity’s attractions
  4. Despite hitting a record high, gold appeals as a portfolio diversifier that lets investors retain higher exposure to equities while hedging downside risk.

The gold price has climbed 30% this year, topping $2,000 an ounce for the first time in the process. After such a scintillating rally, is it still worth investing in the precious metal?

This year’s increasingly uncertain world seems to have lifted the yellow metals appeal. The asset is often a popular safe-haven asset in particularly uncertain times. The risks of a second wave of coronavirus, skyrocketing debt levels and November’s US presidential election are factors that may encourage investors to increase exposure to the commodity.

Fragile sentiment

US equities have bounced by more than 50% from their March low, in the quickest recorded return to a bull market. Valuations are underpinned by easing quarantining restrictions and the authorities unleashing substantial fiscal and monetary firepower to counter the economic effects of coronavirus.

With so much hope seemingly placed on finding a vaccine, risk-asset valuations appear fragile. There are many reasons suggesting that equities might struggle to maintain their upward momentum. As such, it is unsurprising that investors have been looking to hedge equity positions. Gold has profited from such caution with exchange traded fund holdings in the metal rocketing by 31% this year.

Low-rate prospects to gold’s liking

Gold’s zero interest-bearing credentials can be a disadvantage. However, the pandemic has triggered aggressive policy responses, including ramping up quantitative-easing programmes. Indeed, some central banks took rates into negative territory, aiding gold’s attractions.

Bond yields might be lifted much higher, perhaps following stronger issuance or risk sentiment. That said, the real rate tends to matter more than the nominal one. Yields seem unlikely to rise without higher inflation, unlikely in a slowdown, keeping downward pressure on real rates.

Amid the pandemic, sentiment looks set to remain brittle for many months. Furthermore, central banks appear inclined to let governments purchase more debt. As such, yields are likely to stay lower.

Weaker dollar

Foreign exchange market fluctuations can affect gold’s price. Several US-centric risks, like the nearing presidential election and a strategic rivalry with China, recently helped push the greenback to a two-year low. A weaker American currency makes the yellow metal appear cheaper for non-dollar dominated buyers, potentially boosting international demand.

Slowdown dents demand and supply

Central banks’ annual gold purchases last year were the second highest seen in 50 years. Though investment demand for the commodity has been encouraging, physical demand suffered from this year’s slowdown. For instance, jewellery purchases slumped by 46% in the first six months of the year as quarantined economies, elevated prices and labour market disruption hit consumer demand.

On the supply side, virus-related disruption reduced mine-production supply by 5% in the first half of the year. An elevated price could spur capital investment. However, the time needed to exploit fresh projects means that production is often slow to react to market movements.

Shining diversification appeal

Investment demand and recovering physical demand suggests that the gold outlook is positive. Indeed, the rally in the metal’s price this year may have further to run. Furthermore, the commodity has generated an average return of 11.2% per annum in the last ten years.

Gold continues to appeal as a diversification tool within a broader, multi-asset portfolio. Investing in the metal can allow higher exposure to equities, an asset class that is likely to outperform in the medium term, while hedging downside risk.

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