Gold right now appears to be a function of several things. The first one being real rates. As gold does not throw off a yield, the argument against it has always been the lack of carry – you aren’t getting paid to sit and hold the asset. With nominal rates on traditional fixed income securities being so low and real yields now negative – and moving more negative – that cost of carry argument that safe haven fixed income assets have typically provided is no longer a headwind. You are actually losing money in inflation adjusted returns owning most government issued debt. So as real yields push further negative, gold as a store of value seems to be more and more attractive each day.
Second, and related, the supply of safe haven fixed income assets that possess a negative yield is rising every day lately. As the supply of assets that no longer bear a positive yield continues to rise, that puts more upside pressure on alternative safe haven assets like gold as investors seek a means to preserve value as opposed to one that sees its value eroded by inflation by the day. Supply and demand: the supply of negative yielding assets continues pushing the demand up for assets that can retain value over the near term.
Third, the US dollar has begun its retreat against many of the major currencies around the world. And while some of this may be more a function of EUR strength, a weaker dollar also acts as a catalyst for gold as investors once again seek an asset in which to retain their purchasing power. Plenty of reasons for dollar weakness – COVID 19 related worries, elections, real interest rates, growth differentials, fiscal and monetary response – the list goes on and on. But whatever reason you want to cite for USD weakness recently, this is just another catalyst for gold to push higher. Gold is priced in USD and as the USD drops in value, gold becomes cheaper to purchase.
And lastly, from a portfolio construction perspective, with nominal bond yields grinding lower, the functionality of fixed income to serve as portfolio ballast and an offset to equity risk continues to diminish. As US Treasuries push closer to the zero lower bound each day, the ability for yields to rally sharply in times of equity volatility becomes more challenged – something akin to negative convexity in mortgage securities for example. There is much more room for yields to rally when they are at 4% for example versus when they are at 0.53%. As a result, the utility that fixed income provides in a portfolio construction context is becoming less and less each day. Sovereign bonds are not providing real returns and are becoming even more contrasted as they approach the lower bound in terms of their ability to offset equity risk in times of stress. As a result, investors are turning to other means of equity risk offset and gold is one of the options. So how much further can gold rally? Until these 4 catalysts abate, it’s tough to see any meaningful downside pressure to the gold story.
One word of note – gold’s buyer base is a bit different than those say of traditional fixed income buyers. Gold still carries more of a speculative investor base, one that trades it as a commodity and a rental position and not necessarily as a long term investment per se. A slight nuance here which will give it the potential for higher volatility when viewed against a competing asset like safe haven sovereign fixed income. Because of this gold seems much more sensitive to investor positioning and sentiment than Treasuries and safe haven assets for example and we certainly have seen positions building in gold steadily over the past few months.