Gold’s performance this year has been anything but stellar. The yellow metal has been on an incredible bull-run and is up almost 33% from the same time a year ago.
Just 4 months into the year, the metal has already witnessed gains of almost 13% clearly outperforming most other asset classes. It’s no secret that uncertainty – be it political or economic – is a friend to gold and the leap year of 2020 will certainly not be forgotten for many such events- be it spark of geopolitical tensions between the U.S. and Iran, the acquittal of President Donald Trump in an impeachment trial, crash of a Ukrainian flight in Tehran, UK’s departure from the EU or most importantly the spread of the coronavirus.
The metal got a head start of almost 5% in the month of January buoyed by the tensions between the U.S. and Iran when a top ranking Iranian military commander was killed in an airstrike. However, a major trigger for a rally in gold this year was the spread of COVID-19, the deadly virus which has claimed over a quarter million lives and has left millions of people stranded across the world. The pandemic induced crisis has seen the unemployment claims rise to more than 33.5 million since mid-March and the claims now account for 13.9% of the US labor force. And the numbers are expected to rise through May since full reopening is expected only in June.The rally in the metal, however, wasn’t an easy one way up move. Prices were very volatile, and the metal briefly turned lower for the year before climbing to its highest level since late 2012. The precious metal was torn between its potential as a haven investment and a mad scramble to sell the bullion in a bid for cash to cover losses in the equity markets.
Covid-19 was declared as a pandemic on March 11, but gold prices didn’t immediately rally as many expected. Infact, the bullion fell a massive 14% to as low as $1451 before eventually edging higher, as increased volatility and margin calls forced levered investors to sell to provide liquidity. The fall in gold along with risk assets was because the Fed was not easing as fast as inflation expectations were plunging. As a result, real rates rose, and gold prices fell despite the perception of the commodity as a haven. During the 2008 financial crisis, gold faced similar losses with gold prices initially falling in the line with markets. The turning point for the metal in 2008 came when the U.S. Federal Reserve announced quantitative easing, at which point gold began to soar.
Likewise, given the recent unprecedented monetary and fiscal stimulus measures from governments and Central banks across the world, the metal has staged a powerful recovery. The futures edged to as high as $1,788 an ounce on 14 April after trading in the $1,400 range less than a month ago. This was also time when the world witnessed massive surge in the spreads between the spot and futures contract. The spread between London spot gold and New York futures which usually trades within a few Dollars rose to near triple digits in the last week of March.
What caused the Cash/Future spread to Spike?
It was not like the world suddenly ran out of gold, however there was a lack of gold in the desired proportions. Gold markets in London (spot price) deal in the 400 ounces bar whereas 100-ounce bars are delivered against New York futures trading in Comex. In normal times, the conversion of larger London bars into COMEX-acceptable units is a seamless process. The Corona virus pandemic, however, forced the refineries (majorly located in Switzerland & Germany) to temporarily suspend operations and also disrupted flights between many nations. This drove traders into panic as many feared that there will be a shortage of 100-ounce bars for delivery in New York and led to the surge in premiums. With many countries now relaxing their lockdown measures, two of the world’s biggest gold refiners are almost back to pre-COVID-19 operations. Besides, Insurance firms have started covering charter flights to carry gold. Consequently, the spread has also narrowed to nearly $5.
Global recession forecasts combined with the rapid pace of governmental money-printing to boost the activity in gold.
Working in favor of gold are the monetary and fiscal stimulus measures, which do not seem to have an upper limit. World leaders have committed almost $8 trillion to battle the COVID-19 and its economic fallout, driving debt up to dangerously high levels. Rapidly increasing debt-to-GDP levels are driving gold prices higher. It was the financial crisis that launched U.S. debt-to-GDP to post-World War II highs. A similar story developing may support gold even more in the years ahead. The unprecedented monetary stimulus has seen yields on US 10-year treasuries plunge to 0.70% while German 10-year bonds are trading at a negative yield of -0.50%. With high quality treasury paper yielding next to nothing, gold has become an attractive store of value in comparison.
The metal has held on to its gains despite the run up in equities as countries have started relaxing the lockdown measures and reopened their economies. Concerns over a second wave of infections is supporting the safe-haven demand.
With the ongoing geopolitical, economic and financial market risks, there is little reason to believe the long-term upward trend in gold prices will change anytime soon. According to IMF, the global economy is expected to shrink by 3% during 2020 which will mark the steepest downturn since the Great Depression of the 1930s. With an official recession looming, monetary authorities are poised to buy record amounts of financial assets and double the sizes of their balance sheets. The U.S. Federal Reserve balance sheet has already exceeded the $6.2 trillion mark up from $4.2 trillion in February ($4.5 trillion was the prior peak as a result of the Great Recession).
When policymakers act to accommodate shocks such as the one being experienced now, gold tends to benefit as it is considered as the currency of last resort, acting as a hedge against currency debasement. There are expectations that Fed’s balance sheet could surpass $10 trillion and the fiscal 2020 U.S. budget deficit is expected to quadruple to a record $4 trillion given the steep economic downturn and massive coronavirus rescue spending.
Reflecting these sentiments, Holdings in SPDR Gold Trust, the world’s largest gold-backed ETF, rose to 1,076.39 tons on 5th May, their highest since April 2013. According to World gold council, the global investment demand for gold rose by 80%yoy in the first quarter this year. Gold-backed ETFs saw inflows of more than 298 tons in the first quarter (+300%yoy), which pushed holdings in these products to a record high above 3000 tons.
Nevertheless, the yellow metal's continued gains depend on the Fed's ability to retain control of economic expectations, and keep real rates trending lower. If the economic turmoil prompts a bout of deflation given the massive fall in oil prices which the Fed proves unable to address, the precious metal could come under pressure. However, that seems unlikely. The propensity of governments to indiscriminately flush systems with cash promises adds fuel to the bullion price rally. Besides the prospects of renewed US-China tensions is adding further buoyancy to the metal. In the current environment where interest rates are expected to remain low for a very long time, the yellow metal remains poised to reclaim the 2011 high of $1920 as it is a long-favored hedge against recession, uncertainty and inflation. Gold played a key role during a historically poor first quarter as equities around the globe suffered massive losses amid COVID-19 panic. Going forward, the yellow metal continues to be a must in a well-diversified portfolio as the length and amplitude of the Covid-19 shock on the global economy are simply unknown.
The propensity of governments to indiscriminately flush systems with cash promises to add fuel to the bullion price rally.
Data Source: Bloomberg
Arun Leslie John
Chief Market Analyst