The price of gold continues to reach record highs. Can I invest in it?
After the global outbreak of the coronavirus, it caused huge fluctuations in financial markets. Stock markets in various countries, from the US to Europe to emerging markets, plummeted in March. The global bond market and commodity market have also plummeted, and many bonds are at risk of default. The data shows that the global corporate bankruptcy rate hit a new high in the second quarter after the financial crisis broke out in 2009. With the spread of the epidemic, major central banks around the world, from the Federal Reserve to the European Central Bank and the Bank of Japan, have begun to introduce large-scale monetary easing policies. The Federal Reserve's balance sheet expanded from less than $4 trillion to $7 trillion in less than three months. The sharp increase in liquidity has caused stocks in various countries to enter a bull market. The Nasdaq market, which is dominated by technology stocks, has reached a record high 28 times in a row this year. The global bond market also joined the bull market feast. The markets, including US Treasury bonds, corporate bonds, and high-yield bonds, have all recovered from the March decline. US Treasury bonds and real estate mortgage loans soared, and yields hit record lows. Gold was also not absent from this liquidity-driven financial market carnival, rising sharply by more than 36% since the end of March. So can investors buy gold now? This article analyzes some of the fundamentals of gold and provides an outlook on the next trend.
1. Gold's safe-haven function
Western financial markets have a saying: the existence of gold keeps central bankers honest. One of the unique features of gold is risk aversion. It can be said that in thousands of years of human history, gold has provided a tool to hedge against the depreciation of the fiat currency and the misuse of currency risks by the central bank in every war and unstable situation. This is why central bank officials in various countries often express some negative views on gold. The last few years have been no exception. Every time a geopolitical risk incident occurs, gold will rise on a pulse. For example, the situation in North Korea is tense, such as the outbreak of conflict in the Middle East, such as the outbreak of terrorist attacks, etc. However, as long as risks subsided, gold fell faster than news headlines. The benefits of shorting gold on high prices are very good. It's quite interesting that the Inca civilization used gold as an excrement of the gods. Arguably, the rise in gold caused by geopolitical events is generally unsustainable. It is more suitable for investors to speculate on changes in risk appetite in the market, but they cannot invest in gold for long-term reasons due to risk aversion. After the recent outbreak of the coronavirus, the gold market also skyrocketed in the early stages. After the epidemic eased, it plummeted, and then surged again after the second wave of the global epidemic. The main reason is that gold itself has no profit, unlike stocks, which have dividends, and bonds have interest. Once the market stabilizes slightly, speculators will sell gold and pursue other profitable financial assets.
II. Gold's alternative currency function
Another major function of gold is an alternative currency. In other words, unlike the dollar, the euro, or the renminbi, central banks of various countries can create it. Gold requires significant costs to be mined and smelted to remove impurities and improve purity. As a precious metal, gold's intrinsic value is hard to replace. Central banks in all countries have the urge to overspend money in the medium to long term. These continuously issued currencies will eventually lead to inflation. Therefore, as long as inflation continues to rise, the price of gold will continue to rise. After the outbreak of the coronavirus, the Federal Reserve invested heavily in financial markets. The balance sheet rose by $2 trillion in March 2020, from $4 trillion at the beginning of the month to $6 trillion. Money circulation increased by about 50%. The European Central Bank, the Bank of Japan, and the Bank of England have all implemented similar monetary easing policies. However, monetary easing does not necessarily lead to inflation right away. The most obvious example is the Central Bank of Japan, which has been implementing quantitative easing in Japan for more than 30 years, yet the inflation rate is still around zero. The European Central Bank also found similar results. The reason is that total money circulation in society = base currency X speed of money circulation. The current global financial market is likely to see a continuous rise in basic currency issuance, but the rate of currency circulation continues to decline, making it difficult to cause deflation. In this case, the increase in gold is likely to be limited.
It is worth mentioning that every global financial crisis is accompanied by tight liquidity. After the financial crisis broke out in 2008, liquidity was tight, and gold first plummeted and then rose. The author believes that the current global economic crisis caused by the coronavirus may also repeat the situation in 2008. The reason why gold rose and then fell in March may also be due to tight liquidity. Finally, the emergence of a large number of cryptocurrencies over the past decade has to some extent replaced the safe-haven nature of gold. In the long run, gold may continue to be marginalized and withdrawn from the mainstream investment stage. Only residents of countries that are relatively isolated from the global open financial system, such as Russia, India, and Iran, may need gold to preserve value and hedge against the risk of currency depreciation. Some safe-haven operations and value preservation operations that originally used gold may have used cryptocurrencies such as Bitcoin.
III. Relative value transactions of gold and silver
Judging from thousands of years of human history, gold and silver have always been highly correlated as two precious metals. It can be said that in many countries, including China, the United States, and European countries, silver has not only assumed the “double cornerstone” precious metal reserve function with gold, but also played a supporting role for gold. Because of its relatively cheap price, silver has often been called “poor man's gold” throughout history. However, every time the price of gold rises sharply, if the price of silver does not match the rise, it is generally judged that it lacks fundamental support.
This round of gold bullish market in 2020 lacked the cooperation of silver in the second quarter, so many market participants expressed concern. However, since the beginning of July, silver has risen 44%, which can be said to be a late confirmation of the gold bull market. July was also a month in which interest rates on US Treasury bonds fell sharply. As a result, after subtracting the inflation rate, the real interest rate is further negative. This is a major support for the price of gold and the reason why silver has begun to rise: the opportunity cost of investing in precious metals has become negative.
The sharp rise in silver prices in the last month has helped the gold and silver price ratio return to a normal range, which is of positive significance for the next step in the gold market. In fact, due to the huge price volatility of silver, traditional silver mining companies will sell futures in large numbers to lock in profits. If the price of silver can stabilize at a new price level, the futures positions of mining companies will also be a positive factor in the market after the expiration and rollover process.
4. US dollar exchange rate hedging
After the outbreak of the coronavirus, the world experienced tight dollar liquidity for several months, or a “dollar shortage.” As a result, the US dollar exchange rate rose sharply, and the US dollar index broke through 103, a new high in the past few decades. Subsequently, the Federal Reserve provided nearly 500 billion US dollars in currency swaps to the central banks of the world's 14 major economies to ensure abundant liquidity in the US dollar. Beginning in March, the Federal Reserve lowered the federal overnight fund interest rate to zero, and interest rates on medium- and long-term US Treasury bonds fell sharply at the same time, causing interest spreads between the US dollar and developed country currencies such as the euro and yen to shrink and become less attractive. Meanwhile, the economies of various emerging market countries are slowly recovering, and currency depreciation has bottomed out and rebounded. These factors are all causing global liquidity to flow back to Europe, Japan, and emerging markets. The US dollar exchange rate has declined, and the US dollar index has also dropped nearly 8% from its high level. Gold is a good option to hedge against exchange rate risks when the dollar depreciates. As a result, global investors may continue to buy gold to spread exchange rate risks.
5. Industrial and jewellery properties of gold
Gold is also used in many industrial and technical sectors. Due to its very unique properties, gold is used for everything from electronics to space flight. In fact, while gold is still mainly viewed as a commodity, its use in industry and technology is increasing almost every day.
The properties of gold make it a very versatile metal. First, although it's a metal, it's easy to shape and work with. This means that gold can be used where harder metals require greater processing. Furthermore, gold conducts electricity very well, making it a very useful material in electronics. Finally, gold is extremely resistant to corrosion, which means it can be used to rust and corrosive factors of other metals. In short, gold is one of the best metals in the world and is used in some situations. One of the main uses of gold is electronics. Due to its properties, gold can form a very thin wire without breaking. Also due to its plasticity, gold makes an excellent contact node. When gold's electrical conductivity is combined with its natural thermal conductivity, this allows the manufacture of electronic devices that usually overheat and are useful to almost anyone. Another common use of gold is in harsh environments, where it usually causes a lot of corrosion. Due to the nature of space, gold is widely used for its non-corrosive properties. Artificial satellites generally have equipment made of gold. Every spaceship launched by the US uses gold, from instruments to wiring. In the vacuum of space, nothing is more important than any work, and gold stands the test every time.
The medical uses of gold cannot be overlooked either. Gold is probably one of the best metals in dentistry. The ease of gold, combined with its generally low allergenicity and corrosion resistance, makes it an ideal metal for dental fillings. Gold fillers are strong and durable when used in combination with hardeners. However, the use of gold in the medical field is not limited to dentistry. Gold is also used in the medical community to diagnose and treat arthritis.
Gold's function as jewelry will last for a long time. For thousands of years in human history, all ancient civilizations have liked to use gold as a symbol of wealth and status. I personally also enjoy visiting gold mines, gold smelters, and gold mints. As a consultant at the J.P. Morgan Global Commodity Research Center at the University of Colorado's Denver campus, I have had the privilege of visiting deep underground gold mining sites several times. The feeling of holding gold sand in the gold mine and holding the BRICS in the gold smelter is amazing. The Central Bank of Canada's mint and the Federal Reserve's mint are all open to the public. The author also suggests that everyone can visit and experience the gold production and smelting process on site.
6. Gold spot and futures markets
There are actually two markets for gold, and they are closely linked because investors, investment banks, and gold miners are active in both markets. The first is the physical market, which brings together gold mining companies, jewelers, central banks, electronics manufacturers, banks, and investors. London is the focus, which dates back to Brazil's first gold rush in 1697. Shanghai, Zurich, Dubai, and Hong Kong are also hubs. The second gold market is the futures market, which is used to exchange financial contracts based on gold. This market is electronic and consists of the New York Gold Exchange, the Shanghai Gold Exchange, etc. It gives investors an opportunity to speculate on the rise or fall of the price of gold. These futures contracts do not hold physical gold, and gold mining companies also participate in hedging transactions on gold exchanges.
Prices in these two markets often have room for arbitrage. After the outbreak of the coronavirus, hundreds of tons of gold in stock were airlifted to New York every month, causing the gold spot warehouses to fill up, and futures prices were higher than spot prices. However, on futures delivery days, the price of gold often fluctuates greatly due to market makers' limited stocks. Judging from the number of positions announced by the US Commodity Futures Trading Commission (CFTC) this year, speculators' net long gold positions are now much higher than in 2018-2019. Therefore, financial speculators need to beware of the trampling effect of overcrowded long gold transactions after a profitable withdrawal.
In summary, global inflation is currently extremely low, so the profit prospects for investing in gold to hedge against inflation are limited. However, various risk events occur frequently, and investors can completely take short-term operations and use their gold positions to hedge against huge shocks in the stock market and bond market. However, the spread of negative interest rates reduces the opportunity cost of investing in gold, and is also a favorable factor for gold. Finally, in order to hedge against the risk of the depreciation of the US dollar, proper allocation of gold also has positive effects.
Source: Kevin Chen Kaifeng Chen
