In the latest Investable Universe podcast episode, Juan-Carlos Artigas, Head of Research at the World Gold Council, offers his take on the convergence of market factors that have supported gold in recent months.
He explains that gold price trends are an interplay of four distinct factors, two strategic and two tactical. Short-term, tactical demand for gold can be explained by factors like interest rates and relative currency strength that inform investor attitudes about the opportunity cost of gold (compared to other assets), while price momentum can amplify existing price trends. Strategically, economic expansion supports demand for physical gold in jewelry, technology and as a long-term savings vehicle. But gold is also counter-cylical, performing well in market downturns as uncertainty surrounding riskier assets (like stocks) leads investors to seek “safe haven” assets (or simply to hedge or diversify their portfolios against the possibility of such a downturn).
In 2020, all of these factors were made manifest. In August, the LBMA (London Bullion Market Association) PM Gold Price reached an all-time intraday high of $2,067.15/oz, while the metal also set historic high prices in all other major currencies in 2020.
And while gold’s strength in the first half of the year was driven by mass risk aversion, coupled with price momentum, during the early phases of the pandemic, researchers at the World Gold Council say continued price strength during the second half of the year was linked more closely to demand for physical gold investment (either through ETFs or bars and coins), rather than through futures contracts. This, they say, supports anecdotal evidence that gold was widely used in late 2020 as a strategic investment, rather than a purely tactical play.
Still rolling
This robust demand case is still rolling in 2021. Commonly used equity market metrics (including the S&P 500 price-to-sales ratio, which is at unprecedented levels) point to record-high (and possibly overstretched, depending who you ask) valuations for equity markets, which when combined with a continuing regime of low interest rates, could contribute to volatile market swings and significant pullbacks (for example, on headline risks pertaining to covid, from vaccine efficacy to distribution logistics to reports of new mutations).
Inflationary concerns are rising in 2021, amid ballooning fiscal deficits due to post-covid fiscal stimulus measures, and rapidly expanding money supply, all factors feeding inflationary pressures that many central banks (including the ECB and the U.S. Federal Reserve) have indicated they will tolerate even if consumer prices rise temporarily above target bands. Gold prices have historically risen in periods of equity weakness and in high-inflation environments: the Council notes that gold prices have increased an average 15 percent in years when the rate of inflation exceeded 3 percent.
The unevenness of global economic recovery may also support the demand outlook for physical gold, particularly in China, where gold demand is positively correlated with economic growth, and which has rebounded more quickly than other countries after strict lockdowns in early 2020. The same is true, to a lesser extent, in India, where the World Gold Council says initial data from the Festival of Dhanteras in November, on the first day of Diwali (a holiday traditionally observed by buying precious) showed a “substantial recovery” in jewelry demand from Q2 lows, despite an overall below-average demand trend.
Additionally, the Council says, central banks—despite some variability in demand in the second half of 2020, and below record buying levels in the preceding two years—ended 2020 as net purchasers of gold, and are likely to continue buying gold in 2021 as part of their foreign reserves.
Finally, mine recovery is likely in 2021, with fewer production stoppages this year following a peak in interruptions during the second quarter of 2020, as major companies have had time to introduce new protocols and procedures to limit the impact of work stoppages due to covid outbreaks.
Sorry, bitcoin
What about the “other” finite asset that’s come on the scene in recent years, with claims of counter-cyclicality, portfolio diversification, inflation hedging, and safe haven-type properties (namely, bitcoin)? Can cryptocurrency give physical gold a run for its proverbial money?
Artigas says no, adding that besides genuine scarcity, gold offers a “dual dynamic” for investors: while it’s an acknowledge storage of value, it’s also a productive asset for manufacturing, with a unique and not-easily-substituted combination of physical attributes that make it a sought-after industrial commodity.
“Not only is gold finite, it’s scarce. It’s a scarce asset,” says Artigas. “There are very specific physical and chemical properties that make gold valuable for human civilization. It’s very malleable, it’s not corrosive, it doesn’t oxidize, which means that it can be [incorporated in] electronic components…And it’s very dense, which basically means that it contains a lot of value in small volume. So, the fact that gold is what it is, is not a random coincidence.”
Additionally, Artigas explains, gold strikes a balance between being a scarce market but one that’s sufficiently large and liquid (with trades of $140 billion ever day), allowing many types of market participants to invest, from retail to institutions and central banks, without creating distortions in the market. This particular combination of attributes is unique as an asset class—and not one that will be easily supplanted (or replicated) by any cryptocurrency. While Bitcoin itself may be finite, the universe of other cryptocurrencies is theoretically infinite (although stablecoins backed by physical gold are just a digital way of expressing a fundamental view on the underlying market).
“Our perspective is that we understand that blockchain technology and cryptocurrencies are revolutionizing financial markets in many ways…But that doesn’t mean that they replace gold,” Artigas says. “Actually, gold can play a strategic role, and can potentially help investors mitigate some of the risks that they incur as they expand the set of assets—including cryptocurrency—in their portfolio.”
For investors who’d like to test out their own market hypotheses according to the traditional four drivers of gold prices, the World Gold Council offers a free, Web-based tool called Quorum, which integrates its own gold valuation framework (developed by Juan-Carlos Artigas) using pre-packaged or customizable market scenarios from Oxford Economics.
