Gold
Gold is dubbed “inflation hedge” or “crisis commodity”, so it wasn’t a surprise when investors started betting on gold after the Fed acknowledged that inflation is not transitory. But after a short-lived peak in March, gold prices declined and the expected results did not come to fruition. At least not yet. In this post, we will first review the contributing factors to the price stagnation, followed by the future outlook.
See below the price of gold since 1975. Prices spiked during the late 1970s and early 1980s when inflation was high (the Great Inflation). They spiked again subsequent to the financial crisis of 2008.
The chart below zooms in the past six months. After a peak in March 2022, the prices declined gradually. The peak in March was partially due to geopolitical instability after Russia invaded Ukraine.
REASONS FOR WEAK GOLD
Strong USD
Historically, USD (measured by DXY Index) and Gold showed a negative correlation. The chart below tracks the prices 25 years back.
The consensus is that the USD will maintain its strength through the next few quarters. The position of USD as reserve currency and the fact that many countries have used USD to borrow (hence have to pay interest in USD) further contribute to the strength of dollar. The idea of a stronger dollar has been floating in the investment community for a while. Brent Johnson introduced Dollar Milkshake Theory in 2019, predicting the strength of the dollar against other currencies. Watch this video for further information.
Weak yuan
According to Goldman Sachs, Chinese consumers account for almost one-third of global retail gold purchases. China’s economy has shown signs of weakness in the past few months due to the strict zero-tolerance COVID-19 policy as well as issues within China’s real estate market. As a result, the yuan weakened and with it, the buying power of Chinese consumers.
Higher yields on US treasury bills
As the US Fed hikes rates, the US treasury bills become more desirable and attract liquidity. For many investors, a safe investment with a guaranteed return is much preferable to a speculative asset.
Full capitulation still has not happened
The recent rebound in the stock market (July 2022) proved that many investors think that the worst is behind us. Implied in this idea is that inflation will subside to the Fed’s target of 2% within a couple of months and the Fed will pivot and cut rates. So, we still haven’t seen a flight to safety.
Bitcoin (digital gold)
We have no solid evidence that bitcoin has attracted some of the liquidity that would otherwise be invested in gold, but the idea is not unfathomable. We consider it a minimal impact contributor.
THE FUTURE OF GOLD
Gold bulls believe that the price of gold will increase by the end of 2022. Crescat Capital is one of the investment firms bullish on gold and silver. They have Youtube series explaining their point of view. Click here for the YouTube link.
In our view, strong USD will be a challenge to gold prices in the coming quarters (see discussion above). That being said, markets still have not priced in a prolonged inflation and the valuations indicate that the market expects inflation to be curbed by Q1-2023, which in our view is not realistic and it will probably last until end of 2023. So, things might change when market comes to a realization that inflation will last longer (perhaps when more data is available). Therefore, gold has the growth potential of reaching March 2022 highs ($2,043). Assuming it goes up to $2,100, with prices currently at $1,800, you’re looking at approximately a 16% gain. The downside risk is that it will go down to pre-pandemic levels of approximately $1,500, in which case you will lose 16%. We assign a 75% probability to the increase scenario and a 25% probability to the decrease scenario, resulting an overall expected 8% return on investment within a 6-month horizon. Given the uncertainties in the market, this seems a good proposition. That being said, you can always invest in treasury bills or guaranteed investment in your local bank, which are at approximately 4% these days. The choice depends on your risk appetite.
HOW TO GET EXPOSURE TO GOLD?
- Buy ETF: GLD (SPDR Gold Shares), IAU (iShares Gold Trust), GLDM (SPDR Gold MiniShares Trust), SGOL (abrdn Physical Gold Shares ETF), IAUM (iShares Gold Trust Micro ETF), BAR (GraniteShares Gold Shares)
- Buy shares of gold companies: Newmont Corporation (NYSE: NEM), Barrick Gold (NYSE: GOLD), Franco-Nevada Corporation (NYSE: FNV), Agnico Eagle Mines Limited (NYSE: AEM), Newcrest Mining Limited (TSX: NCM), Gold Fields (NYSE: GFI), Kinross Gold Corporation (NYSE: KGC), Royal Gold, Inc. (Nasdaq: RGLD)
- Buying physical gold is also an option, but consider the transaction costs as well as safekeeping costs