Gold is once again rallying, as it has periodically since its big fall six years ago. In contrast to those previous spikes, this one may actually succeed in blasting the metal out of its long-term funk.
Any rise would come as welcome news to gold investors. Since it tumbled in 2013, gold has been largely confined to a range between US$1,100 an ounce and US$1,350 an ounce. Following a 3-per-cent jump over the past week, aided by a weak U.S. jobs report on Friday, it is now trading around US$1,341.
In a note this week, Jeremy Hale, a strategist at Citibank, outlined a couple of bullish scenarios. He sees gold moving above US$1,500 if the United States and China fail to reach a trade deal and the U.S. Federal Reserve chops rates. He sees even more room for gains if there is no trade deal and the Fed keeps rates where they are now.
Other analysts have also talked up precious metals in recent months. Jeffrey Currie of Goldman Sachs has argued gold will benefit from a rising demand for defensive assets. Schroders PLC, the British money manager, says gold will benefit if central banks return to delivering dollops of monetary stimulus.
The case for gold rests on a couple of key arguments.
The first argument is that there are few havens left for investors who want to shelter themselves against a slowing global economy. Plunging bond yields over the past few months have delivered a downbeat message. In a classic sign of a recession ahead, yield curves have inverted in Canada and the United States. At this point, North American economies still look robust, but a mild U.S. downturn in 2020 would surprise no one.
So where does an investor go for refuge? The most obvious place is bonds. The prices of bonds move in the opposite direction to bond yields, so the plunge in yields over the past few months has boosted the wealth of bond investors.
Future gains may be limited, though. Bond yields are hovering around their lowest point in two years. Barring catastrophe, the prospect for future gains in bond prices appear limited. Bond proxies – utility stocks and the like, with steady, dependable businesses and predictable dividends – have also advanced strongly. They, too, seem unlikely to climb a lot further.
The Japanese yen, another favourite refuge in anxious times, suffers from much the same problem. It has climbed over the past year and no longer looks like a bargain, especially given the potential for trade disruptions that could hurt Japanese businesses.
So that leaves precious metals. Granted, gold is best known for its ability to shield wealth from inflation and a sustained outburst of inflation hardly seems likely in today’s slowing economy. But at least gold doesn’t depend on successful trade negotiations for its value. It could appeal to the growing number of people who fear rising trade tensions between the United States and China will bring down the stock market.
Adding to the case for gold is a second force – those falling bond yields mentioned earlier. For investors, gold’s biggest deficiency is its lack of yield. However, if other investments aren’t producing much in the way of a payoff either, gold’s absence of cash distributions doesn’t look like much of a weakness.
This is the case right now. Anyone buying a 10-year government bond in Canada or the United States makes essentially zero return after accounting for inflation. So why not buy gold instead?
History shows an inverse relationship between real interest rates (that is, the amount you get paid after adjusting for inflation) and gold prices. When real rates dip, gold prices tend to strengthen. If central banks resume cutting rates, as many expect, and bond yields dip further, gold could enjoy more gains ahead.
The boost could be amplified if future rate cuts weaken the U.S. dollar. The greenback and gold prices tend to move in opposite directions because gold prices are denominated in U.S. dollars and a cheaper dollar makes it easier for international buyers to purchase the precious metal.
To be sure, all these factors are well known and much of the bullish case is already built into gold prices. If the United States and China surprise the world and strike a trade accord at the Group of 20 summit in late June, gold prices could fall back into their long slumber.
Even if the U.S.-China trade spat heats up, investors shouldn’t count on enormous gains. Rather, the primary attraction in adding a small amount of gold to your holdings is its ability to diversify your portfolio and offer a buffer against a shaky economic outlook.
“Given our forecast for subdued global growth, we expect a plunge in the S&P 500 to spur a surge in safe-haven demand later this year,” Oliver Allen of Capital Economics wrote in a note last month. He said strong demand, especially from investors in exchange-traded funds, will drive gold prices to US$1,400 an ounce by the end of the year.
That is not far from gold’s current price. But if you are of the view that this economic downturn has further to run, gold looks more attractive than it has in years.
Ian McGugan