Go for Gold! (Part 1): Fundamental factors looking favorable

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Difficulty: Moderate

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1A) There’s increased demand for safe haven assets as recession fears mount

Gold has been an effective hedge during the worst three US stock market sell offs in the past 50 years. These periods included the 2008 Global Financial Crisis, 2001 Dot-com Bubble, and 1973 OPEC Oil Shock. Gold returned between 12% and 139% during these stock market draw downs.

1B) Record low interest rates lower the opportunity cost of owning gold compared to hoarding cash

Among the major developed countries, US, Canada and Australia are offering the “highest” cash benchmark interest rates of 0.25%. Investors do not lose out much by holding gold instead, despite it being a non-yielding asset.

1C) Gold should remain a reasonable store of value as Central Banks engage in coordinated “quantitative easing” policies

Coordinated quantitative easing policies across developed markets will theoretically lead to interest rates staying low and potential currency depreciation. You can print money but you can’t print gold.

2) Notwithstanding the above, speculative positioning for Gold Futures remains elevated, which may hamper short-term price gains

Speculative net long gold futures contracts are close to 5-year highs, any significant unwinding of these positions will be a headwind for gold prices.

3) All things considered, IQ is moderately bullish on gold. In Part 2 of “Go For Gold!”, we will explore our preferred picks for Gold Miners

The InvestQuest’s View: We are moderately bullish on gold, even after the 13% year-to-date return. However, we prefer to view gold as a risk diversifier in the context of an overall portfolio, rather than thinking of it as a speculative standalone investment. In the article below, we list the different ways to get exposure to gold.

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1A) Increased demand for safe haven assets as recession fears mount

Gold served as a good stock portfolio hedge in the worst sell offs. This is hardly conclusive but looking at the 3 most severe pullbacks on the S&P 500 in recent history, gold has served it’s purpose well as a hedge for stock portfolios.

The gold price rally this year has been tame. In the context of prior gold rallies during the most severe recessions, the return of 8.1% for gold this year pales in comparison.

Over the long-term, returns for gold have lagged stocks. Over the past 30 years, gold has returned 5.3% per annum vs S&P 500 which has returned 9.6% per annum (including dividends). However, as shown above, they can be a good hedge during downturns.

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1B) Record low interest rates lower the opportunity cost of owning gold compared to hoarding cash

Holding gold has had a significant opportunity cost. Unlike cash deposits, owning gold does not generate any interest income. This created a hurdle for would-be gold investors, as these investors would be losing out on the interest income they’d have gotten investing in fixed deposits. However, with global interest rates at record low levels and expected to stay this way for the foreseeable future, demand for gold should remain resilient.

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1C) Gold should remain a reasonable store of value as Central Banks engage in coordinated “quantitative easing” policies

“Quantitative easing“ …just what is it and why is it happening now? Here’s a simplistic step-by-step explanation.

1. Covid comes, government needs money: Economy suffers as a result of Covid-19 pandemic. The government decides to support the economy by providing loans to companies and giving cash to families to tide through the crisis. How is the government going to finance the spending?
2. Tax revenues are not enough, so the government borrows.
3. They borrow this money by getting the National Treasury to issue government bonds. Investors buy the government bonds, so the government is in essence borrowing the money from investors.
4. The Central Bank (a separate entity from the Treasury) then buys the government bonds from the investors, bidding up the prices of these bonds. This part is known as quantitative easing. Yes, one arm of the government borrows by issuing bonds, and the other arm buys back these bonds by “printing” money. The Central Bank does this to keep interest rates low, and to ensure sufficient liquidity is put back into the economy.

All things constant, the above actions result in a country becoming more indebted while maintaining low interest rates. Plus, a probable result would be a depreciation of the nation’s currency. Faced with such an outcome, it then makes sense to hold onto an asset that is a store of value and whose supply is limited – GOLD!

Perhaps Bank of America’s gold price forecast of $3,000/oz is plausible after all.

“Gold is money. Everything else is credit.”

J.P. Morgan (the person himself)

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2) Short-term technical headwinds to Gold

As we write this article, the positioning in gold futures is already relatively crowded, as evidenced by the net long positioning in the Gold Futures market (red line in chart below). This is important to note as there has been a positive correlation between gold prices and net speculative buying demand of Gold Futures.

If speculators decide to unwind their Gold Futures buy positions in a significant way, this might be a headwind for gold prices to trend higher in the short-term.

In our view however, short-term headwinds will likely be overshadowed by strong fundamental demand that we are seeing. Physical gold held by Gold ETFs (chart below) have already doubled since 2016 and is seeing signs of acceleration.

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3) The InvestQuest is moderately bullish on Gold

The InvestQuest’s View: We are moderately bullish on gold, even after the 13% year-to-date return. However, we prefer to view gold as a risk diversifier in the context of an overall portfolio, rather than thinking of it as a speculative standalone investment. In the article below, we list the different ways to get exposure to gold.

Ways to get exposure to gold

1. Buying physical gold (for Singapore residents, UOB seems to offer such services)
2. Buying unallocated gold (avail on most FX brokerage accounts, under the ticker “XAU”)
3. Buy Gold Futures (avail on some brokerage accounts, usually purchased on margin)
4. Buying a Gold Tracker ETF (this ETF tracks gold prices, the largest would be the SPDR Gold Trust, traded under the ticker “GLD US”)
5. Buying a Gold Miner ETF (this ETF tracks a basket of gold mining stocks, the largest would be the VanEck Vectors Gold Miners ETF, traded under the ticker “GDX US”)
6. Buying individual Gold Mining / Gold Streaming and Royalty Stocks

Investopedia has done a decent write up on the above options.

In Part 2 of “Go for Gold!” which will be published next week..

We will be exploring if it is worth getting exposure to Gold Miner stocks. Gold miners have been known to exhibit more exaggerated price moves, compared to actual changes in gold prices. For investors who hold the view that gold prices will continue trending higher from here, buying into gold miners may result in a larger payoff. We will reveal the results of a quantitative screen to see which gold miners have the highest sensitivity to gold prices, coupled with the lowest sensitivity to broad stock market movements.