Updated: May 1, 2020
Gold has been getting significant airtime in recent weeks principally down to the fact that it has been going up. In US dollar terms, gold has run up from $1,300 at the beginning of June to around $1,530 now. There is a long list of short-term catalysts for the move such as the US-China trade conflict and tensions with Iran. However, there are several more fundamental and long-term forces at play that we believe will continue to be supportive of the gold price in the coming years.
Firstly, when Jerome Powell took over as Chairman of the Federal Reserve, he set about establishing his credibility on financial stability and proceeded to allow real interest rates in the US to rise well above where they had been under the stewardship of previous Fed governors, Bernanke and Yellen. Gold as a safe, real, monetary asset competes with other safe monetary assets (sovereign debt) and hence has a strong negative correlation to real yields. With the Fed effectively admitting to a policy error with its final rate hike last year and the subsequent “Powell pivot” in January, some of the increase in real yields has been reversed. This has acted as something of a release valve for gold.
While the recent move leaves gold well short of the $1,900 bull market highs of 2011, it is notable that gold is making new all-time highs in a number of other currencies such as sterling due to the strength in the US dollar. It is no coincidence that real yields outside the US have been pinned at much lower levels. Going forward, we feel that the US experiment with higher real rates provides compelling evidence that a world with high and rising levels of indebtedness simply cannot live with materially positive real rates. This should mean that any pullbacks in gold (which are inevitable) are unlikely to evolve into protracted downturns.
Secondly, the activity of central banks in the gold market demands attention. In 2018, central banks in aggregate bought more gold than in any year going back to the early 1970s. This buying has accelerated and become more diverse in 2019. The Eurasian central banks led by Russia and China have been at the forefront of this trade as they seek to diversify away from the US dollar. However, countries such as Poland have joined in: Poland recently announced it had increased its gold holdings by 100 tonnes to 228.6 tonnes.
Another interesting development came on 26 July, when the ECB announced that the Central Bank Gold Agreement (CBGA) will not be renewed for the first time since its inception in 1999. Under this agreement, that was previously renewed every five years, central banks agreed to limit sales of gold to no more than 400 tonnes per year. However, these sales had all but stopped several years ago anyway. In the communique, the signatory central banks confirmed that gold remains an important element of global monetary reserves and none of them currently has plans to sell significant amounts. The more pertinent question is, has the agreement been dropped to allow the European central banks to join the buyers?
With one hand central banks have stopped putting their reserves into US Treasuries and other sovereign debt while simultaneously buying gold with alacrity. With the other, through regulation they have forced banks, financial institutions and certain classes of investors to buy more sovereign debt at increasingly negative yields that are certain to destroy wealth over the long term. No one is squealing yet as yields continue to fall, notching up mark-to-market gains on sovereign debt. But given the underlying debt dynamics and consequent central bank policy trajectory, in real terms, this trade is unlikely to age well.
We continue to believe strongly that gold will continue to re-establish itself at the heart of the global monetary system as THE neutral reserve asset. This process is already well underway. The reason to own gold is that it is the asset most likely to benefit versus the financial assets that comprise virtually 100% of investors’ portfolios, in the event of a global monetary reset that looks increasingly likely. How much to own is not an exact science. However, the current answer for investors subject to institutionalised asset allocation models and benchmarks, is almost certainly; not enough.