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The Big Q: How High is Too High for the precious Yellow metal?
Q-1 of Y 2020 was positive for gold prices, as the chart below shows. The precious Yellow metal gained 6.2% from 31 December 2019 to 31 March 2020, moving from 1,515 to 1,609 oz. In April, gold rallied to 1,693, increasing gains to 11.7% in and as of Friday’s close the price was 1,713.90 oz or YTD + 13.2%.
Chart 1: Gold prices (London PM Fix, in $) in Y 2020.
The reason for the Bullish move was the C-19 coronavirus chaos (CCC) and the resulting shutdown of the global economy.
As a result of the CCC shock, most of the drivers of the gold prices improved. In particular, the real interest rates, as measured by yields on the 10-yr inflation-indexed Treasuries, dropped, plunging into negative territory.
As one can see in the chart below, gold prices behaved like a mirror image of real government bond yields.
Chart 2: Gold prices (yellow line, left axis, London PM Fix, in $) and real interest rates (red line, right axis, in %, yields on 10-year inflation-indexed Treasuries) in Y 2020.
Plus, the risk premium surged, which supported safe-haven assets like gold.
As the chart below shows, credit spreads greatly widened, while the CBOE Volatility Index (VIX) skyrocketed.
Chart 3: CBOE Volatility Index (green line, right axis, index) and ICE BofAML Option-Adjusted Spreads (red line, left axis, %) from 2 January to 16 April 2020
Some complain that gold’s performance has been soft given the depth of the negative economic shock.
Ok, that is true that gold has not rallied so far, but marking a 13%+ gainer when almost all assets dove makes gold 1 of the best performing asset in Y 2020 or the best.
Gold prices did not run up higher because of 2 Key factors.
- just as in the immediate aftermath of the Lehman Brothers’ collapse, investors started to liquidate gold holdings in order to raise cash. But when the dust settles and the sell-off inevitably ends, the precious Yellow metal will have a cleared path upward, and,
- The USD appreciated amid the CCC, as the chart below shows. The Buck is also seen as the safe-haven during crashes, so investors switched their funds from all over the world and put them into the USD denominated assets. Given the strong negative correlation between the Buck and gold, the appreciation of USD exerted downward pressure on gold prices. However, both gold and Buck can appreciate during the financial crises, as it was the case in early Y 2009. Importantly, the surge in the US fiscal deficit and public debt will weaken the Buck in the longer run.
The Big A: That happened, now what is next for gold. Will the price of gold quickly rally to 5,000 or more, as some analysts claim? No. It is true that the Fed’s balance sheet is going to really expand, and the money supply will too, but there is no correlation between the money supply and gold prices.
As you can see in the chart below, the broad money supply has been rising since the 1970’s when Nixon closed the gold window, but the price of gold has not, instead, the precious Yellow metal experienced a Bull & Bear cycle.
Chart 4: Gold price (yellow line, left axis, London PM Fix, in $) and the US M2 money stock (red line, right axis, in billions of $) from January 1981 to March 2020
The ratio between the fiat money supply and gold’s supply is no simple formula for gold’s fair value.
You see, the claims that the rising money supply could drive gold prices way way North are based on the assumption that the global economy will return to the gold standard, which is very unlikely, no matter whether we like with the notion or not. And we do.
Moving to the aftermath of the Great Recession. The price of gold increased 244%, from 775 on 15 September 2008 to 1,895 on 5 September 2011. So, if history repeats, the price of gold could increase to say, 4,000+. Recall, it was not a rapid rally, it took 3 yrs for gold to reach the highs. Plus, it always easier to rise when you start from lower levels.
There is a risk for gold outlook that CCC will be quickly contained and the economic growth will swiftly rebound.
Many opine the V-shaped recovery is unlikely, even as it happens.
Social distancing will disappear, people will stop wearing mask, they will all go back to work.
The CCC will linger, and The People will come to understand that it just another Fact of Life.
But, there are Southside risks for the economy, which if they materialize may drive gold prices further North. What they might be I do not know, but The Trump Administration and the Fed say they will be there to manage it.
Should this quick recovery continue, as I believe it will, the low interest rates, Dovish Fed and high debt will stay with us, which we all know support the gold prices.
So, fundamentally CCC is very positive gold prices, and the outlook for the precious Yellow metal in Y 2020 has clearly improved and will continue.
The Gold Bugs will feed on the C-19 Coronavirus, and the Fed cannot print gold.
Have a healthy weekend, Keep the Faith!
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