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SINGAPORE: Gold has been one of the best performing assets this year. It hit an all-time high of $ 2,031 an ounce on August 7. Since reaching that pinnacle, it has fallen 8 percent to a three-month low of $ 1,859.
However, there are signs that there could be a renewed interest in the metal. Its price has rebounded above that, and more importantly, the movement in the price of gold this year has defied conventional wisdom.
GOLD VS ACTIONS
Since the beginning of the year, an ounce of yellow metal has risen from $ 1,514 an ounce to $ 1,890 today. The 24 percent rise has outpaced the 21 percent drop in Singapore’s Straits Times Index and the somewhat flat performance of the US Dow Jones Industrial Index for the year.
It has also outpaced the 4 percent pedestrian increase in the MSCI World Index, which is a broad measure of the performance of the global stock market. But it hasn’t matched the Nasdaq’s 32 percent gain this year.
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It’s unclear from this year’s data whether gold’s outperformance of the past 10 months has come at the expense of equities. Historically, when investors turn away from risky assets like stocks, they tend to seek safe havens like gold.
But while there is an indication that this is happening in some markets, the data is not entirely convincing. For example, it doesn’t fully explain why gold and the Nasdaq have traded at about the same pace this year.
If we go back over the last two years, which was when gold first showed signs of earning interest, the move from equities to precious metal is almost as ambiguous.
Since January 2019, gold has risen 54 percent from around $ 1,246 an ounce to its current short-term high.
During that period, the Dow Jones Industrial Average has risen 25%, while the Nasdaq has risen 38%.
Stock photo of gold bullion at a gold and silver separation plant. (Photo: Reuters / Leonhard Foeger / File Photo)
It is not conclusive that there has been a notable shift from equities to gold. But gold has outperformed both the overall US market and the heavy-tech index.
GOLD AGAINST THE GREEN BACK
And the dollar? Gold is considered to have a negative correlation with the US dollar. The reasoning is that gold is priced and priced in US dollars. Consequently, when the US dollar weakens, it could be argued that it is cheaper to buy and hold gold.
Also, from a gold miner’s perspective, they will want more dollars for every ounce of gold they extract from the ground because the dollar is worth less.
But it is unclear if that has happened in the way we would expect this year. At the beginning of the year, the US dollar index stood at 96.5. At that time, gold was worth $ 1,514 an ounce. On March 20, the dollar index rose to a high of 102.8.
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But instead of falling, gold unexpectedly rose to $ 1,605 an ounce.
By mid-October, the dollar index had fallen to 93.8. Gold rose to $ 1,923. The result is that while the US dollar has only fallen 3% this year, gold has recovered 24%.
The movement in the price of gold over the past two years could help paint a clearer picture.
Since January 2019, the dollar index has fallen from 96.8 to 93.2, representing a 4% decrease in value against a basket of currencies that includes the euro, the Swiss franc, the Japanese yen and the Canadian dollar.
Meanwhile, the 48 percent rise in gold during this period could suggest that investors are concerned that the dollar will fall further.
GOLD VS INTEREST RATES
In addition to stocks and the US dollar, gold is also assumed to have a negative correlation with interest rates. The reason is that there is an opportunity cost when an investor buys gold.
The cost to the investor is the loss of interest income that could have been earned if the cash had remained in the bank.
But cutting interest rates by many central banks to near zero has effectively eliminated the opportunity cost.
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In early 2020, the US Fed Funds rate was 1.75%. But the key interest rate fell to between 0% and 0.25% in March.
In September, the US Federal Reserve indicated that it would keep the rate near zero until 2023.
The Federal Reserve Board building on Constitution Avenue is shown in Washington, March 19, 2019. (Photo: REUTERS / Leah Millis)
The Fed is not the only central bank to cut interest rates. Interest rates in the euro zone, Japan, the United Kingdom, Canada and Australia are also at record lows.
There appears to be a good correlation between the rise in the price of gold and interest rate cuts by central banks.
GOLD VS INFLATION
Gold is considered to be a hedge against inflation because it can help guard against declining purchasing power of fiat money. That’s because it is priced in US dollars.
So if the purchasing power of the dollar decreases, then gold could become more expensive, as each ounce of gold would be worth more.
But there is little indication of inflation. In fact, US inflation fell from 2.5% at the beginning of the year to 0.1% in May.
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During that same period, gold jumped from $ 1,511 an ounce to $ 1,686 an ounce, instead of falling. The increase in the price of gold also does not match the reports of moderate inflation in the last two years.
Since 2019, the inflation rate has moderated from 2% to 1.5% in the United States. Meanwhile, gold is up 46 percent.
GOLD VS FEAR
The VIX index, sometimes called the “fear index” or “fear indicator,” is an estimate of the volatility of the economy. While it is not a perfect measure of the level of fear in the markets, it can provide a way to see how investors might view the future.
When the VIX index is high, it can be an indication that they perceive that investments in the stock market are uncertain. But when it is low, they expect stock prices to be less volatile.
The escalation of the trade war adds to growing fears of a possible recession in the United States, and tariffs weigh on both economies and world trade. (Photo: AFP / GREG BAKER)
Greater uncertainty in the stock markets can be a boon for gold prices, as investors can look to safer assets like gold to invest their money in.
In March, the VIX soared to a high of 85. It coincided with the time when COVID-19 had spread to many parts of the world.
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Gold prices soared from a low of $ 1,474 to $ 1,617 an ounce before climbing to a high for the year as scale and fears of disruption from the pandemic began to unfold.
Although the VIX is back to more normal levels around 25, gold prices are still high.
WHERE DOES IT GO FOR GOLD?
There is no single reason that we can identify for gold prices to hit their all-time high this year. Instead, the price hike appears to have been driven by a multitude of factors.
These include concerns about the ability of companies to recover to pre-pandemic levels and the unprecedented level of support provided by central banks that could devalue paper money, especially the dollar.
There is also concern that central banks that have committed to keeping interest rates low for longer may do so, even if it is at the expense of controlling inflation.
FILE PHOTO: Gold bars stacked in the safe room of the Pro Aurum gold house in Munich, Germany, August 14, 2019. REUTERS / Michael Dalder / File photo
The dual concerns of low interest rates and higher inflation could have helped boost the price of gold.
Finally, fear of the unknown and the desire of households to preserve their wealth could have been another driver of the rise in gold.
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It is unclear how long the five gold price drivers will remain.
If they do, the story behind the 2020 gold surge is unlikely to end.
But if any of the drivers need to be removed, then this could be as good as gold for now.
David Kuo is the co-founder of The Smart Investor and previously the CEO of Motley Fool Singapore.
