The pandemic gold rush

15 September 2020

6 minute read

As the gold price sets record highs, surging government debt levels, COVID-19 infection risks and low rates mean that the rally may have more to run.

Key points:

  1. The gold price has surged by 30% this year as the commodity’s safe-haven appeal attracts investors
  2. While equities are setting fresh highs, caution seems warranted amid heightened uncertainty. The rally in the gold price looks far from over
  3. Central banks remain keen buyers of the commodity. However, this year’s recession has hit traditional demand and supply sources
  4. Gold still appeals as a portfolio diversifier, allowing investors to retain higher exposure to equities while hedging downside risk.

The gold price has zipped up 30% this year, hitting a record high and topping $2,000 an ounce for the first time. After such a strong rally in the price, is it still worth investing in the precious metal?

Gold, often cited as the ultimate safe-haven asset, seems to be increasingly popular in a highly uncertain world. Fears of a second wave of coronavirus, skyrocketing debt levels and November’s US presidential election are helping encourage investors to boost holdings in the commodity.

Caution warranted

Amid the pandemic, the S&P 500 is up more than 50% from its March low, in the quickest recorded return to a bull market. The bounce in valuations is supported by shrinking containment restrictions and substantial fiscal and monetary firepower designed to fight the effects of the virus.

Nevertheless, sentiment seems fragile, with plenty reasons why equities may be unable to maintain upward momentum. Such caution has encouraged investors to hedge their equity positions. Gold has been a beneficiary, helped by its reputation as a store of value. The amount held by exchange traded funds has soared by 31% this year.

Low real rates

Gold’s traditional disadvantage is that it’s a zero interest-bearing asset. However, the pandemic has encouraged policymakers to respond aggressively. Central banks have cut interest rates, in some cases into negative territory, and ramped up bond-buying programmes.

While improving risk sentiment or rising bond issuance could push yields much higher, potentially tarnishing gold’s appeal, it is the real rate which matters, not the nominal one. And it is unlikely that bond yields will rise without higher inflation, which should keep real rates low.

Overall, it seems likely that sentiment will remain brittle for some time and that central banks may accommodate government debt purchases to allow additional borrowing. As a result, yields are likely to stay lower.

Pandemic hits demand and supply

Central banks have been one of the most significant buyers of gold over the past decade. Last year, the banks made their second highest level of annual purchases in 50 years.

While the investment demand for gold has aided the price, physical demand was dented by the COVID-19 interruption. For instance, jewellery purchases slumped by 46% in the first six months of the year as quarantined economies, elevated prices and labour market disruption discouraged consumers from buying the precious metal.

Turning to supply, mine production levels have surged over the past ten years. But virus-related disruption reduced supply by 5% in the first half of the year. Relatively high prices should encourage capital investment. That said, the long lead time often needed to exploit new projects means that production levels are usually slow to react to market movements.

Diversification attractions in tact

Buoyant investment demand and recovering physical demand suggests that the outlook for gold is positive. Indeed, the rally in the metal’s price this year may have further to run. 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 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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