Gold begins its course from feisty August, when rates sizzled off to $2,075 per ounce. But, will gold rates peak again in September?
After a stupendous run-up in prices in July, gold was trading in uncharted territory as it entered August. It hit all-time highs of $2075 per ounce at the start of the August (Aug 7), only to correct sharply by 7% in the following week as Russia rolled out Sputnik V, its Covid-19 vaccine, lifting investor sentiment globally.
Though the fundamentals are incredibly supportive of higher prices, the lightning pace at which gold prices increased remains a concern (certainly, warranting a healthy correction).
The rest of the month too saw gyrations in the gold price as the US dollar and US Treasury yields oscillated between risk-on and risk-off, reacting to conflicting developments. Spot prices has settled to $1970 per ounce levels, 0.3% lower by the end of the month. Does it indicate the end of the gold rally?
Also Read: Here's how much gold rates peaked in August
Have the bulls run their course?
With the sharp price correction of August, the question everyone is asking if the bulls have run their course. The recent decline appears temporary in nature and like every bull market, this one too looks like a corrective, consolidative phase. In fact, the Gold Bull Run from 2000 to 2012 had 7 reasonably-sized corrections and so could this one. Gold certainly holds strong potential over the long-term as its fundamentals are stronger than ever.
The main reason why we expect the gold bull market to run for at least a few more years simply because policy-making is increasingly getting dominated with the theory that more monetary inflation, more credit expansion and more government spending will fuel economic-strength.
Massive and unserviceable mountains of government debt are piling up throughout the developed world in a bid to stimulate pandemic-hit economies. This is making central banks around the world print unprecedented numbers of dollars and other currency in order to finance the government’s bills. With a worsening pandemic and sluggish economic recovery, it is hard to imagine a scenario where governments and central banks around the world will change this accommodative stance any time soon. The result will be currency debasement and years of financial repression in order to service the debt. Gold, which is a stable form of money which promises to store value over long time periods, will thus increasingly become the preferred choice for investors and savers seeking wealth preservation.
The Fed gets even more flexible
At the annual Economic Policy Symposium in August, Mr. Powell confirmed speculations by announcing that the Federal Reserve will be updating its monetary policy framework as it adapts to a pandemic-struck world where weak growth and high unemployment are seen as here to stay. In a historic policy shift, the central bank of the United States will now adopt an “average inflation” target that will allow inflation to run above 2%, to make up for past shortfalls and support aggregate demand.
What this effectively means is that the Fed Chair and his colleagues have given themselves significantly more room to maintain ultra-low rates over the next couple of years, as the economy recovers from the Covid impact. This will fuel a deeper drop in real or inflation-adjusted bond yields in the medium-to-longer term, which will be supportive of non-interest-bearing gold.
Amidst rising inflation expectations, Fed is determined to cap the rising bond yields leading to a large decline in real interest rates and the real 10-year yield moving well into negative territory. This puts significant downward pressure on the dollar and on the other hand an upward pressure on commodities and financial assets priced in dollars. The notion of not allowing the bond markets to price in rising inflation expectations could only exacerbate the shift that’s currently underway to hard assets and other instruments that offer inflation protection. It will then be difficult for the central banks to bring back the lost confidence and will require a move like Paul Volcker’s use of super-high interest rates as a way of subduing inflation in the 1980s. This will eventually lead to a sharp decline in economy and risk assets. Gold would likely be a key beneficiary of the erroneous policymaking of negative real rates.
Welcome US political uncertainty
With Democratic candidate Joe Biden currently leading the polls, President Trump is expected to stir things up in the 2 months leading to Election day.
In an attempt to cover up the botched coronavirus response, Trump has been busy fast-tracking vaccines, negotiating more stimulus, and upping the ante against China. To add to the mess, there is growing concern that the pandemic situation may lead for postponing the elections. What this translates into is even higher US debt levels, dollar weakness and heightened geo-political uncertainty, all of which will be supportive of gold prices.
Vaccine: Important, but not for Gold
Governments around the world are expediting the usual approval processes in order to deliver a Covid-19 vaccine quickly. In fact, Russia has rolled out a vaccine already, but there is skepticism about its safety and efficacy, considering the ramped-up timeline. To put things into perspective, the fastest a vaccine has ever been made is 5 years and this one’s here merely months into the pandemic. Even if one was to ignore that, large scale manufacturing and a public launch is months away. Thus, stock market optimism on Russia’s announcement was short-lived.
There is no doubt that a successful vaccine’s impact on the health effects of the pandemic will be positive, as and when a large-scale roll-out is achieved. But it can't undo the extraordinary economic damage caused over the last few months overnight. Thus, even though the announcement of a vaccine may lead to a temporary correction in gold prices, and drive up risk sentiment, ground economic realities will take time to fix. And thus, the major driver of the current gold rally - accommodative central bank policies will continue to operate for the foreseeable future, supporting economic growth as well as gold prices over the medium to long term.
Gold's near-term movement will no longer be linear in direction, with a host of dynamic factors at play. But the macroeconomic tailwinds that instigated the bull market in gold in the first place, are very much intact, and are expected to stay that way for the next few years. This suggests that there is possibility of positive price movement in store going ahead. Price corrections are temporary and are thus good entry opportunities for those seeking to establish long positions in the precious metal. Maintain a 10-15% allocation to gold as it's the counterweight to paper money which is continuing to lose credibility as a store of value.
Chirag Mehta is a Sr Fund Manager for Alternative Investments with Quantum Mutual Funds and tweets at.
Disclaimer: Views and opinions are solely informational in nature and should not be construed as an offer or solicitation to invest in Gold or bullion markets. The information above should not be an alternative to seeking personalized financial advice from a certified analyst. The article was moderately edited by a Sify staff.