Written by: Arkadiusz Sieron, PhD
No matter what shape the recovery is, the epidemic will likely have lasting, positive effects on the gold market.
I’ll start with the report “Recovery paths and impact on performance” about the gold mid-year outlook 2020. The World Gold Council notes that gold had a really excellent performance in the first half of 2020, rising almost by 17 percent (see the chart below), much higher than other major asset classes.
Given gold’s impressive gains, adding between 2 and 10 percent in gold to an average investor’s portfolio would have resulted in higher risk-adjusted returns over the pandemic and economic crisis (as well as over the past decade). Similarly, according to a separate WGC’s research, higher allocations to gold would have improved the performance of a typical central bank’s total reserve portfolio during the coronavirus crisis.
When it comes to the future, the WGC points out that expectations for a V-shaped recovery are shifting towards U-shaped or even W-shaped (a double-dip recession). Such transformation keep uncertainty high, supporting save-haven assets such as gold.
However, the key takeaway from the report is that no matter what shape the recovery is, the epidemic will likely have a long-term, positive effects on the gold market, strengthening the role of gold as a portfolio diversifier. According to the former WGC’s analysis of potential impact of coronavirus crisis on the gold market, the deep recession would be, of course the best for the gold prices, but even in the scenario of swift recovery, gold would shine this year and maintain positive returns until 2022, as the Fed would keep its monetary policy loose, while the real interest rates would remain close to zero.
Supply Disruptions Made Gold Prices Disconnected
In a former report entitled “Gold supply chain shows resilience amid disruption,” the WGC notes that the pandemic has caused unprecedented disruption to various parts of the gold supply chain, but the gold market has remained resilient after all.
However, the epidemic and the resulting supply crisis has hit the retail segment, which is more fragmented, has more complex supply chain, and holds less stocks of small gold bars and bullion coins. This is why “the supply and logistical issues caused depletion of some dealer inventories and left many investors facing long wait times and high premiums”. So, not necessarily manipulation, but supply disruptions explain the high premium for coins over spot price.
Interestingly, and somewhat similarly, the logistical disruptions – and not necessarily malicious conspiracy – triggered by the coronavirus and the Great Lockdown caused the widening of the differential between the London spot price and the futures price on Comex, which jumped from $2 to $75 at one point.
Implications for Gold
Not surprisingly, the WGC is, as always, bullish on gold. The organization believes that “the combination of high risk, low opportunity cost and positive price momentum looks set to support gold investment and offset weakness in consumption from an economic contraction”. This time we agree with the WGC. The coronavirus crisis and the following economic crisis and the response of the central banks and governments significantly shifted the already bullish fundamental outlook for gold prices into an even more bullish one, also potentially strengthening the role of gold as a strategic asset.
The thing is that the Fed and other central banks have cut interest rates to zero and reintroduced or expanded the quantitative easing. In consequence, equity and bond prices are elevated, which increases the risk of pullbacks. Moreover, the soaring fiscal deficits and public debts raise concerns about the sovereign-debt crisis, or a long-term run up of inflation. All these risks and uncertainties related to the ongoing pandemic and fragile economic recovery could increase the role of gold as a strategic hedge in investor portfolios.