Why gold has continued to shine in the year 2020?

Let us understand what exactly has driven the rally in gold, especially the sharp rally in the last 6 months to a year.

Jul 15, 2020 08:07 IST India Infoline News Service

Gold prices have been trading at above $1800/oz during the second week of July 2020. This is significant for two reasons. Firstly, this is the closest that gold prices have got to the life time high of $1900/oz that gold scaled in 2011. Secondly, this is the shortest time frame (9 years), within which gold has retraced its secular highs after a correction of over 40%. The chart below captures the 20 year movement of spot gold prices globally.

Figure 1 - Spot Gold Price ($/troy ounce) over last 20 years

Chart Source: Trading Economics

If you look at the last 20 year chart of spot gold prices, it almost saw an 8-fold rally between 1999 and 2011. However, post September 2011, gold prices corrected from around $1900/oz down to $1050/oz in early 2016. Since then, gold has shown a sharp rally virtually retracing all the losses since 2011. Just in the last 12 months, gold prices have rallied by 50% from $1200/oz to $1800/oz. What exactly has driven this rally in gold, especially the sharp rally in the last 6 months to a year? This rally can be divided into 2 distinct phases.

Phase 1: July 2019 to December 2019

During the six months period between July 2019 and December 2020, the price of gold rallied nearly 25%, making it among the best performing asset classes during that period. A number of factors triggered this rally. Firstly, the trade war showed no signs of relenting and global economies were wary about a distinct trade-war driven slowdown. That led to a rush for safety towards gold. Secondly, recession looked a distinct possibility as demand for metals, capital goods, automobiles and oil started shrinking rapidly. To add fuel to the fire, the US yield curve displayed negative slope twice in succession, a foolproof signal of impending recession. Thirdly, stock markets across the world were overpriced even by their own historical benchmarks. Markets ranging from the Dow to NASDAQ to FTSE down to the Nikkei, Nifty and Straits Times looked stiffly valued. This created a safe haven portfolio shift from equities to gold.

Phase 2: January 2020 to July 2020

Chart Source: Bloomberg

After a 25% rally between Jun-19 and Dec-19, gold has rallied another 19% in the first six months of 2020, resulting in a 50% return on gold over the last one year. This is the dollar price appreciation and the rupee appreciation was much higher as it was also aided by a weak dollar; but we will not get into that. What drove the gold prices in 2020? Firstly, it was the huge fear psychosis created by COVID-19. The global GDP is expected to contract by nearly 5% in 2020 with developed economies likely to contract deeper than the emerging markets. A 5% contraction in global GDP with a virtual lockdown across large swathes of the world economy is a classic recipe for a gold price rally.

Secondly, there have been aggressive rate cuts by most central banks. The US Fed has already cut rates close to zero and the RBI has cut rates by 125 bps in just 2 months. Combined with an upsurge in liquidity infused by central banks, we could see another round of currency debasement happening. This could position gold as a much safer currency considering its limited supply. Thirdly, joblessness has been rising in the US and across the world and that is the perfect setting for investors to prefer gold as an asset class. The renewed demand for gold is evident from the way gold ETFs are raking in flows.

Where is gold headed in the coming year?

It would be hard to call asset prices like gold in the midst of such trying circumstances. The recent equity market bounce is predicated on the hope that global growth will bounce back as will consumer demand. If that does not happen, gold could see resurgence in demand after a brief pause. Traders and portfolio investors may choose to remain long on gold till the growth uncertainty is obviated; substantially if not totally.

Estimates of gold prices in the next one year vary with some investment houses like Goldman Sachs projecting gold at $3000/oz by end of 2021. However, even most gold sceptics appear to be unanimous about gold scaling above the psychological $2000/oz mark in the year 2020 itself.

Finally, 2020 may be different from 2011. Back then, the combination of low rates and liquidity infusion led to a massive rally in equities globally, which lasted all the way till 2019. Most markets scaled new highs during this period. However, the economic impact continued to be muted. This time around, investors are likely to be a more cautious about the causal link between liquidity and economic growth. That means; gold may enjoy a bull run for some more time!

Related Story

Open Free Demat Account (Rs699)