Our Chief Market Strategist, John Reade, joins Chris Mellor, Head of EMEA Equity and Commodity Product Management at Invesco, to address questions raised by investors around the potential benefits of gold.

Questions addressed in this interview include:

• What are the reasons behind the growing demand for gold?
• What role does gold play within an investor's portfolio? 
• How can investors access gold? 
• What effect had ESG investing had on gold? 

The stock market embraced the weakest one-week performance since the financial crisis last week on the back of growing concerns of the continued spread of the coronavirus across the globe. Despite the risk off-moves, gold was lower by more than 3% last week, which is historically unusual during these types of movements. There are a few potential reasons for the weakness.

• First, gold is the strongest performing major asset class this year; the only one in positive territory at this point, up over 5%. This may have led to some profit taking

Major markets performance YTD*

*as of 28 February 2020
Source: Bloomberg, ICE Benchmark Administration, Solactive AG, World Gold Council

• Along with profit taking, sentiment in the COMEX futures market via net longs was extremely bullish, at all-time highs of 1,209t. Extreme positioning, both bullish and bearish, can sometimes lead to reversals in price.

COMEX net longs 

Source: CFTC, Bloomberg

• We often discuss gold as a source of liquidity in times of crisis. Prior to the move in the markets, leverage in risky assets like stocks were at lofty levels. The quick, sharp, sell-off could have caused margin calls, requiring liquidity sourcing from liquid assets like gold. Gold trading volumes, finished the month sharply higher, more than 20% above the 2019 average, at $180bn a day.

But there are shifts that could bode well for gold.

• Investment demand for gold, particularly in the gold-backed ETF space remains strong. Last week there were inflows of over $1.5bn, and in February, global gold-backed ETF holdings grew 4% to new all-time highs. This was on the back on inflows in all-regions. We will release our February updated report on gold-backed ETF flows this Thursday.
• We often discuss the opportunity cost of holding gold. Bond yields in the US, in particular the 10y and the 30y, have reached all-time lows. Overnight, the 10-yr touched the 1.0% level. As yields move lower, gold becomes more attractive from an opportunity cost perspective
• As rates have fallen sharply, the probability of Federal Reserve cuts moved to expectations of 3.5 cuts in 2020, with a 100% predicted cut of 50bps at the March meeting. As noted, gold tends to outperform during periods of Fed easing.
• Technically, Gold remains in a bullish uptrend, despite last week’s pullback, and could continue higher as long as it holds the 50-day moving average of approximately $1,562/oz.

Gold price

Source: Bloomberg  

• Finally, as we noted in the 2020 Gold Outlook, our suggested drivers of gold remain. Market uncertainty, weakening global economic growth, and gold price volatility are likely to drive the market. As shown below, we already started to see a large increase in short-dated implied volatility of gold, where the levels reached those last seen in 2016.

Gold 30- day implied volatility

Source: Bloomberg

The US Federal Reserve (Fed) announced an emergency 50bp rate cut yesterday, bringing the Fed funds rate down to a 1-1.25% range, in response to ongoing concerns about the potential impact of the coronavirus outbreak to the global economy. Treasury bond rates followed suit, with the 10-year note hovering 1% at the time of writing – an all-time historical low (Chart 1). ¹

Chart 1: Historical US 10-year Treasury note yield *

*As of 3 March 2020.
Source: Bloomberg, Federal Reserve, World Gold Council

The unscheduled rate cut is not unprecedented: the Fed cut rates by 50bp in January 2008 in between meetings as issues surrounding the US housing market started to mount. But, at the time, the funds rate was above 4%, giving the Fed greater firepower for further future cuts. Their margin for more cuts is now far slimmer and may require them to resort to alternative policy tools – a fact the markets seem to recognize. After an initial positive burst on the news of the cut, the US stock market gave back its gains as the day progressed. Year-to-date, most major US stock indices are down by 3% or more.² The stock market may behave differently later in the week, but in our view, yesterday’s performance speaks to the potential concerns investors might have on: 1) the impact of the outbreak on the real economy; and 2) the effectiveness of a rate cut to limit such impact. 

In contrast, the gold price has soared so far in 2020, reaching an intra-day high of US$1,650/oz yesterday and increasing by almost 7.5% year-to-date – one of the best performing asset classes (Chart 2). Our analysis suggests that investors have been adding gold to their portfolios to hedge an increasingly volatile environment – 30-day volatility for the S&P 500 has jumped to more than 27%, double last year’s average – with the coronavirus outbreak the latest addition to a long list.

Chart 2: Major markets performance y-t-d *

* As of 2 March 2020
Source: Bloomberg, ICE Benchmark Administration, Solactive AG, World Gold Council

The rate cut should further support gold investment demand, even if consumer demand softens. In fact, our research suggests that the gold price has historically increased by twice its long-term average in periods of negative interest rates (Table 1), such as the one we are currently in. To that extent, investors may consider replacing part of their bond exposure with gold to help more effectively hedge stock market risk.

Table 1: Gold performance nearly doubles in periods of negative interest rates

Gold performance in various real rate environments*

*Based on nominal gold returns between January 1971 and December 2019. Real rate regimes based on the 12-month constant maturity US T-bill minus the corresponding y-o-y CPI inflation. Difference from zero computed as a two-way T test at a 5% significance level.

Source: Bureau of Labour Statistics, Federal Reserve, ICE Benchmark Administration, World Gold Council

Footnotes

¹ wsj.com/articles/yield-on-10-year-treasury-note-reaches...

² As of 3 March 2020. Based the levels of the S&P 500, DJIA and NASDAQ indices at the time of writing.

This week, we launched our February 2020 ETF flows report, which highlights the positive impact current market volatility is having on investment flows in gold-backed ETFs.

Inflows across all regions of nearly US$5bn during February (84.5 tonnes), boosted total gold ETF growth to 5% over the first two months of the year. Gold ETF assets values have grown 50% over the past twelve months as holdings continued to reach new highs of 3,033 tonnes, or US$153bn.

This trend has continued in the first week of March as gold moved higher. Through the first four trading days of March, global gold ETFs have added and additional US$2.3bn or 1.4%. 

In the report, we note some of the drivers including:

• Market uncertainty, volatility and the economic impact of the coronavirus
• Lower interest rates and Fed easing
• Gold price outperformance, compared to other major asset classes
• Bullish investment positioning in the golf futures markets, and
• Gold separating itself from other commodities

Wishful thinking. That’s how Angel Gurría, secretary general of the Organisation for Economic Co-operation and Development (OECD), responded to any prospect of a swift economic recovery from the coronavirus pandemic. But the scale of the impact on the global economy – as well as our daily lives – has been matched by the scale of the financial response.

Who’s cutting in 2020?

While sluggish economic growth and geopolitical uncertainty was expected in 2020, the swift and sizeable impact of the coronavirus outbreak has led to policy decisions few expected. Under these unprecedented circumstances, central banks have taken even more action in order to prop up the global economy. The US Federal Reserve (Fed) has made two unscheduled rate cuts this year – the first unscheduled action since 2008 – bringing rates to near zero. But they were far from alone. The action was co-ordinated with the eurozone, the UK, Japan, Canada and Switzerland.

Last year, we published a blog post which looked at how central banks around the globe had been cutting interest rates in response to slowing economic growth, the growing pile of negative-yield debt, and what this meant for gold. Our conclusion?

"…opportunity cost has been the most important factor driving the gold price up in 2019…interest rates have been lowered and the stock of negative yielding bonds has grown rapidly, lowering the opportunity cost for holding gold. Falling rates and negative returns have made government debt less attractive and have increased the possibility of higher inflation and currencies depreciation in the future."

Source: Bloomberg

Fiscal policy joins the fight

On top of this, central banks and governments around the world are injecting trillions of dollars – far in excess of the levels seen in response to the Global Financial Crisis in 2008. And this week, the Fed went even further, by announcing unlimited asset purchases, and, for the first time, buy corporate debt. Some of the notable stimulus packages which have been announced are:

• Fed will inject US$4tn of liquidity through business loans, while the US government has agreed a US$2tn stimulus package
• The European Central Bank may remove limits – currently €750bn (US$821bn) – on its Pandemic Emergency Purchase Programme¹
• Germany has enacted a loan programme – through its state-owned bank KfW – which could provide up to €550bn (US$610bn) in corporate loans
• Italy unveiled a €25bn (US$28bn) in stimulus plan, split into two packages, which includes loans to small- and medium-sized companies
• The Bank of Japan is significantly increasing spending on ETFs and corporate bonds, and the Japanese government has issued two loan packages totalling nearly US$20bn

Investopedia give a more detailed summary of all the monetary and fiscal stimulus measures being put into place so far. But these unprecedented actions to maintain the flow of credit, in the hope of limiting the damage to the economy, could profoundly distort asset prices and allocations in the years to come.

Beyond short-term fluctuations

The impact of these co-ordinated cuts and stimulus measures has been limited, so far anyway. And questions are again being asked on whether these are ultimately blunt tools, leaving central banks without much out of room to manoeuvre in the future, and governments with ballooning debt piles.

Investors are still worried about of the full impact of coronavirus on the global economy, resulting in the heightened levels of volatility across markets. And gold has not been immune to this volatility. The price has fallen significantly in recent weeks, as investors look for liquidity in order to stem losses elsewhere in their portfolios. But beyond this recent negative price action, the policy decisions that are being made in response to the coronavirus pandemic are likely to have long-lasting implications on the global economy, and, as a result, continue to support gold investment demand for the foreseeable future.

Footnotes

¹ https://www.bloomberg.com/news/articles/2020-03-26/ecb-will-scrap-bond-limits-for-its-pandemic-purchases-program