14 September 2020

Gold – Store of value, imperfect hedge

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Unintended consequences of worldwide monetary policy stimulus


In the past six months central banks across the world, including in emerging market economies, have aggressively cut their policy rates (often to record lows), instituted expansive QE programs (the purchase of government and corporate bonds) and injected liquidity into banks (see Figure 1).

Figure 1: Unconventional monetary policy has distorted “plain-vanilla” returns and boosted price of gold
Source: 4X Global Research

 

Fall in real bond yields and global outlook concerns boosting gold’s relative attractiveness

These measures have led to a collapse in global yields and slow Dollar depreciation and left households and corporates – often deprived of spending and investing opportunities – and financial institutions flush with cash, in turn stoking fears about a rise in global CPI-inflation. At the same time, while global equities have rallied a further 5.9% in the past month, the global economic and financial landscape remains acutely uncertain in the context of the covid-19 pandemic.

This backdrop of falling real returns on US government bonds and depressed corporate bond yields has boosted the relative attractiveness of gold as a store of value, which does not pay interest (“carry”) or dividends (see Figures 2 & 3), and a hedge for a weaker Dollar and a potential correction in global equities. As a result the price of gold has surged to close to $2,000/oz, despite a fall in the “real” global demand for gold (including from China), while the price of silver is hovering above $28/oz at a near record-high.

Figure 2: Real US Treasury yields have collapsed into negative territory… Figure 3: …and AAA corporate bond yields are still near multi-year low
Source: 4X Global Research, St Louis Federal Reserve (FRED) Source: 4X Global Research, Moodys, St Louis Federal Reserve (FRED)

 

Material increase in Dollar-value of Middle East central bank gold holdings

The 14% increase in the price of gold since end-May has materially boosted the Dollar-value of central bank gold holdings in the Middle East.

Figure 4: Qatar and UAE central banks have materially increased gold holdings in recent years Figure 5: Surge in gold price has boosted $-value of Middle East central bank gold holdings
Source: 4X Global Research, Gold Hub, investing.com
Note: * up till end-May 2020
Source: 4X Global Research, Gold Hub, investing.com
Note: * Assumes unchanged volume of gold holdings since end-May 2020

In particular we note that the central bank of Qatar has since 2014 increased its gold holdings by about 29.8 tonnes to 42.2 tonnes as of end-May 2020, while the UAE’s central bank, which had no holdings of gold until 2015, has since build up gold holdings of about 31.5 tonnes (see Figures 4 & 5). We estimate, assuming no change in the volume of gold holdings since end-May, that the Dollar-value of central bank holdings has increased by $2.5bn in Saudi Arabia, $0.6bn in Kuwait, $0.3bn in Qatar, $0.25bn in UAE and $36mn in Bahrain (see Figure 5). This will, along with the 29% increase in the price of Brent crude oil since end-May, have provided further support to Middle Eastern central banks’ overall FX reserves (see Crude Oil Sweet Spot, 31st July 2020).

 

Gold remains an imperfect hedge to US Dollar positions …

Between 2010 and early 2019 the price of gold was more often than not inversely correlated with the Dollar Nominal Effective Exchange Rate (NEER) and thus gold was a useful hedge to Dollar positions (see Figure 6). The 15% rally in the price of gold since mid-June has more than compensated for the 3% fall in the Dollar NEER. A foreign investor who had bought gold (priced in Dollars) would have lost money on the Dollar leg of the investment but more than likely gained far more on the gold leg. However, in the past 18 months this inverse relationship has not always held, with gold and the Dollar tending to move in tandem (see Figure 7, green shading), denting gold’s status as a Dollar hedge.

Figure 6: Gold and Dollar were inversely correlated for a decade… Figure 7: …but this has not always been the case in the past 18 months
Source: 4X Global Research, Federal Reserve, Gold Hub, investing,com
Note: * Nominal Effective Exchange Rate (23 April 2010 = 100), Federal Reserve trade weights

 

….and to global risk aversion

Similarly, and contrary to popular belief, the price of gold and global equities have for long stretches not moved in opposition but in the same direction (albeit at different speeds), as has been the case since early March (see Figures 8 & 9, green shading).

Global equities and the price of gold fell 23% and 11%, respectively, between 6th and 20th March. One explanation is that the collapse in global equities and overall returns may have forced investors to sell gold holdings and move into cash (for example to make margin calls). In any case an investor long gold as a hedge to a long equities position would have lost out on both legs of the trade. Conversely, since 20th March both gold and equities have rallied, with the percentage rise in gold since mid-June (14.3%) greater than the rise in global equities (11.5%). The equity rally may have given investors greater financial latitude to accumulate gold (and other assets), pushing its price higher.

Figure 8: Gold has in recent years not been a particularly good hedge to global equities Figure 9: Gold and global equities going up, albeit not at the same speed
Source: 4X Global Research, Gold Hub, investing.com
Note: * MSCI All Country World Index is weighted index of over 3,000 large and mid-cap stocks in 23 developed and 26 emerging markets

 

Silver outshining gold and no longer “cheap” in relative terms

Price action in recent months suggests that investors and markets view gold as a store of value, particularly when real yields are very low, not simply an (imperfect) hedge for a weaker Dollar or potential correction in global equities.

Silver is not typically thought of as safe-haven asset but historically the price of gold and price of silver have tended to move in the same direction if not always at the same pace (see Figure 10). Indeed during the height of global risk aversion, from 24th February to 18th March, the price of gold fell 10.4% while the price of silver collapsed 38%. As a result the ratio of gold-to-silver prices surged to a record high of about 127 (see Figure 11).

Since 18th March, however, the price of silver has increased about 134%, more than four times as much as the price of gold (31%) and the ratio of gold-to-silver prices has collapsed to around 70. This ratio is now only moderately higher than the average ratio since mid-2007of about 66.5 (see Figure 11). The price of silver, unlike gold, has arguably also been spurred by global imbalances between declining supplies of (quality) silver and rising demand (including in electronics).

Figure 10: Price of silver has surged in absolute and relative terms…. Figure 11: …and gold-to-silver price ratio has fallen back in line with historical standards
Source: 4X Global Research, Gold Hub, investing.com Source: 4X Global Research, Gold Hub, investing.com

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