The coronavirus pandemic, U.S. presidential election, economic uncertainty, stock market volatility, historically low-interest rates, fiscal spending on stimulus, and continued quantitative easing have been the headlines of 2020. However, as macroeconomic and geopolitical uncertainties persist amid continued debate of additional fiscal and monetary intervention, one asset is poised to continue its 2020 outperformance: gold.
As the budget deficit increases with near-zero rates and a resurgence of COVID-19 cases expected, quantitative easing domestically has become much more complicated. It does not help that all this uncertainty happened during an election year, heightening the doubt of regulations and policy implementation. This accompanied by the looming cloud of coronavirus resurgence propelled further economic dislocations, thus, causing the U.S. dollar to continually get whipsawed. With little clarity in sight, the U.S. dollar’s headwinds present a persistent devaluation trend.
Furthermore, although the economy has shown signs of resiliency, the recent economic adversities put pressure on corporate earnings, operations, and growth metrics resulting in market volatility and asset class pricing gyrations. These occurrences have caused many investors to seek alternative streams of return. Gold fills this gap perfectly.
It is a common notion that the U.S. dollar and gold prices have an inverse relationship. Therefore, as the U.S. dollar depreciates, gold likely appreciates. This holds true as gold continues to outperform in 2020 as the U.S. dollar weakens. There are many reasons to argue why gold became the haven asset for 2020. One of the most significant advantages is gold’s supply and demand matrix. Gold supply remains limited, and demand remains rangebound. Both retail and institutional investors, alike, have limited demand appetites. Retail investors gravitate towards high flying and speculative technology stocks rather than tangible assets like gold. Meanwhile, institutional investors use gold primarily as a placeholder for cash, with only 1% to 3% of assets allocated to gold (on average). Therefore, gold’s supply is limited, and demand is rangebound, providing a healthy environment for the precious metal to see continued positive trajectory.
The current environment does not depict the common notion that higher gold prices resemble a defensive sentiment, especially with the University of Michigan Consumer Sentiment for October improving to 81.2, beating consensus estimates. However, some of the main reasons’ gold has outperformed resides in:
- a weakening U.S. dollar;
- continued COVID-19-driven economic uncertainty;
- ambiguous policy administration from U.S. Presidential election;
- record stimulus packages;
- a strengthening euro;
- record trade and budget deficit;
- excessive levels of negative yield sovereign debt globally; and
- negative real rates making gold’s 0% interest attractive.
Many believe that gold has an inverse relationship to interest rates as well, but this is only partially true. Real rates, not nominal rates, drive gold prices. Real rates are interest rates adjusted to remove the effects of inflation, while nominal rates account for inflation. As real rates turned negative, gold’s 0% interest rate becomes increasingly more attractive (as seen below). Therefore, gold’s divergence from real rates can be driven by a potential shift in U.S. Federal Reserve inflationary bias amid the current thematic backdrop. Gold’s inflationary hedging debates aside, this precious metal provides a good way to hedge stagflation or persistent high inflation, high unemployment, and sluggish economic growth. Based on the current economic backdrop, stagflation remains a viable possibility.
Bloomberg: Catalyst Capital Avisors LLC, 10/20/20
With this explained, gold’s technical indicators also remain bullish. Ironically, gold experienced a “golden cross” of its moving averages with the 50- and 100-day moving averages surpassing its 200-day moving average back in February of 2019. Since then, gold broke out of a seven-year “U” shaped base when it breached $1,450 in August of 2019, eventually retesting the new support in March of this year. After retesting the newly established support of $1,450, gold has surged roughly 29.7% in 2020. Historically, the last time a seven-year base was established, between 1996 to March 2004, gold increased approximately 357% (399.55 $/oz to 1,825.55 $/oz) through August 2011. Though the situation is vastly different, gold’s optimistic technical backdrop supports the thematic and fundamental bullish sentiment.
Bloomberg: Catalyst Capital Advisors LLC, 10/20/2020
All in all, gold remains a shining star amid a turbulent 2020. Gold’s inverse relationship to a weakening dollar, healthy supply and demand metrics, and bullish technical signals all point to gold outperforming in the medium term. The market seems to agree as gold futures have experienced a steep contango (future price of a commodity rests higher than the expected spot price of the contract maturity), indicating strong demand with prices likely to rise. Whether using it as a cash alternative or an alternative asset to hedge traditional portfolios, gold is the answer. With a full economic recovery a long way away and an expected COVID-19 resurgence likely, additional stimulus packages, policy uncertainty, and fiscal spending increases will likely continue. If that is the case gold could remain the steady winner.