OPINION: Gold in a time of crisis – our safe haven
“Gold is a way of going long on fear” – Warren Buffet
THE CORONAVIRUS pandemic has seen a global health crisis turn into an economic one. It remains uncertain as to when the world will recover from either of these. The past century has shown us that the monetary system tends to change about every thirty years.
Prior to 1914, the monetary system was based on the gold standard. Thereafter, 1945 saw the Bretton Woods system. Within the Bretton Woods system, the USD became the world’s reserve currency. In today’s terms, we have a monetary system older than 50 years – asking for a change. Will the change once again involve gold?
Gold is usually priced in dollars and tends to move in the opposite direction to the dollar. This is due to the fact that when the USD gains, it takes fewer dollars to purchase an ounce of gold. Furthermore, gold is considered to be a good hedge against the risk of inflation since the increasing costs of goods and services tend to erode the value of the dollar.
During and after the financial crisis of 2008, gold prices rose by more than 150%, from $750 per ounce in 2008 to $1 900 per ounce in 2011. These prices occurred within market uncertainty and low interest rates. As such, it is generally stated that the best times to own gold is during macroeconomic uncertainty and financial contagion.
It is expected that the gold price will be supported going forward, not just because of uncertainty over global growth, but also by the amount of monetary stimulus currently in place – which is likely to keep interest rates low in the near future. Furthermore, gold is seen as a free market currency which is not dependent on the USD.
The disruption of global supply chains caused by COVID-19 makes the global economy susceptible to stagflation because production may not be able to respond to governments’ stimulus. In the event of this occurring, we could see gold prices rising much higher than what they currently are.
We have seen stocks rally 4.5% during May, taking their total gains to 39% from their lows in March. When we put these results in the context of an estimated 52.8% annualized decline in GDP during the current quarter, equity valuations have risen to new record highs.
The new reading in the Buffet Yardstick yields a 10-year forecast for equities of -6% per year, including dividends (based on the 80% negative correlation between the two).
However, from the chart above, returns over the past decade have exceeded this measure’s forecast by several percent per year, so it’s certainly possible for the market to avoid such a nasty fate. The difference between forecast and actual returns can be explained by sentiment. When investors are overly confident, stocks outperform their fundamentals and vice versa.
Now that sentiment has begun to rapidly decline, it would seem reasonable to expect the excess returns of the past decade to be given back and possibly in short order. This would mean the S&P 500 Index would have to fall approximately to the 1,750 area, more than 40% below its current price. However, for gold to reclaim its safe haven status, we will need to see a selloff in the market, along with a possible correction.
This will be kick started by some form of bad news, such as a second wave of Coronavirus outbreaks globally. It appears as though risk sentiment is turning to the cautious side, with investors once again starting to flee to the safe haven commodity.
The graph below illustrates the long-term trend in gold prices. It is evident that the financial crisis of 2008 initially had a significant impact on the gold price, where after it rallied to reclaim its safe haven status. As such, we can expect gold prices to rise in the near future as investors are starting to flee to the safe haven commodity.
When we think of history repeating itself, it is safe to assume that gold prices will rise sharply in the coming months as it did during the financial crisis of 2008. Throughout history, investors who held gold were able to successfully protect their wealth and, in some cases, even use the commodity to escape from all of the economic confusion.
Consequently, whenever there are news events that hint at some type of global economic uncertainty such as COVID-19, investors often flee to gold as their safe haven. Thus, with the uncertain times ahead, it is safe to assume that gold will once again become the global safe haven.
This opinion piece was researched and written by the TreasuryONE Dealing Team. You are welcome to phone or email us and discuss your view on the topic.