<p>Gold is currently trading at around $1,620 today after testing recent highs of $1,675 and lows of $1,460 all in a few weeks in March! Gold initially lost about 15% during this COVID-19 induced financial crisis over the past couple of weeks but has started to gain much of this back. We've seen this before and there are good reasons why.</p><p>The initial drop, and perhaps perceived underperformance, has disappointed many gold bulls and questioned the notion of its safe haven status. The pundits who have been banging the drum that the markets will crash were right but for the wrong reasons – the market collapse is a black swan event, more like a terrorist attack but not systemic. But they also suggested gold will rise out of the ashes of any financial nuclear winter and provide holders of gold massive returns with prices expected to reach $2,000. $3,000 or $10,000 per ounce. So, with gold not off to the races, what is happening?</p><p><img style="display: block; margin-left: auto; margin-right: auto;" src="https://kradminasset.s3.ap-south-1.amazonaws.com/ExpertViews/alastair1.png" /></p><p style="text-align: center;">Source: tradingview.com</p><p>Gold, while initially dropping by 15%, did its job as a portfolio stabilizer. All other asset categories such as currencies, oil, copper, equities etc, all got pounded. Those who have followed my posts will note comments that the real flight to safety always remains, at least initially, in the USD and US treasuries. Note in the charts below, the sharp drop in the 2 year and 3-month US treasury yields (falling yield/rising price) and the strength of the Dollar Index over the last few weeks. These were going up as everything else saw red.</p><p style="text-align: center;">US 3 Month Treasury - Source: CNBC</p><p><img style="display: block; margin-left: auto; margin-right: auto;" src="https://kradminasset.s3.ap-south-1.amazonaws.com/ExpertViews/alastair2.png" /></p><p style="text-align: center;">2 year USD Treasury - Source: CNBC</p><p><img style="display: block; margin-left: auto; margin-right: auto;" src="https://kradminasset.s3.ap-south-1.amazonaws.com/ExpertViews/alastair3.png" /></p><p style="text-align: center;">USD index over the past 3 months - Source: barchart.com</p><p><img style="display: block; margin-left: auto; margin-right: auto;" src="https://kradminasset.s3.ap-south-1.amazonaws.com/ExpertViews/alastair4.png" /></p><p>Before going further, it is important to understand that gold is priced in US dollars, and therefore as the dollar rises, the price of gold falls, caeteris paribus. During the crash, the dollar was gaining strength (and US treasuries purchased with USD) because of its safe haven status and because asset liquidations around the globe are/were accelerating. These events created a growing shortage of dollars and this demand for dollars, pushed up the value – we are now seeing 19-year USD high.</p><p>Gold weakness during market selloffs simply suffers the fate of the dash for cash and (historically) sells off in turbulent markets; either, to meet margin calls in other financial instruments or is liquidated to seek value in other oversold markets. This should not come as a surprise. Gold during the GFC in 2008 rose to $1000 per ounce but fell soon after by as much as 25%, to around $750/ounce. We also observed the same in 1987, on Black Monday, where gold initially rose by a couple of percent but overall gave up 5.8%. Not much mind you, but again the result was the opposite of expectations.</p><p>This is not all bad news for the gold market, typically gold outperforms after equity crashes. But before that discussion, let's look back to early 2019 when gold began its ascent. This move began on the back of a reversal of monetary policy by the Fed, moving from hawkish to dovish, to address the building risks in the market. While employment figures were good, wage growth and inflation were benign. The treasury market strengthened and the R word (recession) began to circulate as yields inverted. Later in the year, the Fed cut by 25% and treasury yields fell further. In addition, Europe appeared to be technically in a recession and in an effort to stimulate the economy, the European Central Bank and sovereign nations were now implementing a negative interest rate policy. This means it is the bond holder who pays interest to the lender! Here, the market really began to focus on the negative real interest rates and its effect on gold. Gold began a good run in late 2019 and early 2020.</p><p><img style="display: block; margin-left: auto; margin-right: auto;" src="https://kradminasset.s3.ap-south-1.amazonaws.com/ExpertViews/alastair5.png" /></p><p style="text-align: center;">Source: Incrementum</p><p>So, what does all of this mean going forward. First off, gold outperforms after significant equity sell offs. Why, because of the liquidity added to the system through macro-economic and fiscal stimulus packages – macro tweaking or outright bailouts. This action ultimately will negatively impact the USD. The year 2011 is a very good example where at least three rounds of Quantitative Easing were implemented. Here, the Federal Reserve repurchased US treasuries (where normally they issue treasuries) to inject liquidity into the market. In essence, repurchases increases the price but lowers the yield thus keeping interest rates low. The net result powered up gold to its high of $1,917 in August 2011.</p><p><img style="display: block; margin-left: auto; margin-right: auto;" src="https://kradminasset.s3.ap-south-1.amazonaws.com/ExpertViews/alastair6.png" /></p><p style="text-align: center;">Source: Capital Economics/mining.com</p><p>Going forward, I would expect to see the US government, the Federal Reserve and central banks globally to roll out massive financial rescue programs to support their economies and address a very serious concern over the expectations of a recession. We are seeing the beginnings of this now. The US just recently announced a two trillion-dollar rescue package; but the popular consensus among economists, the amount needed is likely to be at least $4 trillion. With such a large supply of dollars added to the system, this will ultimately begin to weaken the dollar once the safe haven trade begins to unwind.</p><p>Note the quote from the WGC. “Looking ahead, we believe the deceleration in economic growth will undoubtedly impact gold consumer demand and gold’s volatility may remain high, but high-risk levels combined with widespread negative real rates and quantitative easing will be supportive of gold investment demand as a safe haven.” Well, as mentioned, safe haven may not be the best choice of words but for sure expect gold to minimum test the 2011 highs of $1917.80/ounce in the medium term.</p><p>In the meantime, the following is a good summary:</p><ul><li>Broader market sell offs lead to asset liquidation and a flight to safety through acquisition of USD and US treasuries. </li><li>This creates a dollar shortage which leads to a rising dollar value and for gold this leads to a falling price in USD</li><li>Volatility prevails and margin selling of gold further adds to gold weakness</li><li>Macro-economic policies, focusing on stimulus packages, creates a surplus of dollars</li><li>A surplus of dollars causes dollar weakness and gold strength</li></ul><p>Finally, there is much chatter about the lack of retail physical gold available (coins, small bars etc) as a result of the significant uptick in physical demand. This is all good but unlikely to influence the underlying price. For sure, this helps with sentiment but in general all that is impacted is the physical premium for the underlying products such as small bars, coins etc. The price is only influenced at the institutional level through the futures market and OTC trading. Incidentally, the net longs are currently at their most net-long gold position since May of last year when gold traded about $1,280/oz.</p>
KR Expert - Alastair McIntyre
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