Lest we forget, on one Thursday in late June, most journalists were poised around midnight with articles half at the ready about the victory for a Remain vote in the UK referendum. The result caught almost everyone off guard, after it emerged a small majority wanted out.
The pound crashed, panic ensued, and yet few were surprised to hear gold prices had soared. As unexpected as the referendum result was, the sudden spike is largely in keeping with a rally going back to before the start of the year.
The price of gold (in USD terms) has performed admirably this year, rising 25 percent in the first six months and outperforming major asset classes including stocks, bonds and many commodities. According to Juan Carlos Artigas, Director of Investment Research at the World Gold Council: “The rise in price is mainly as a result of ongoing market uncertainty around Brexit, the US elections, a shift in market expectations in favour of far slower rate hikes in the US, and continued changes in monetary policy.”
William Adams, Head of Research at FastMarkets, pointed out that prices turned a corner around the start of the year, reversing ways on what was then a downward trend. The rally off the $1,046.40-per-ounce low in November started to gain momentum in early January, prices rebounding a total of $329, increasing some 31.5 percent since the low. “It’s a strong rally that looks to have further to go, but not without corrections along the way”, according to Adams.
The price of gold has performed admirably this year, rising 25 percent in the first six months
Turbulent political and economic climate aside, these prices are also a symptom of collapsing confidence in fiat currencies, and herald a change to the way in which investors interpret financial markets. According to James West, author of the stock market newsletter Midas Letter: “In the present era of economic management, currencies are largely derived from debt, and so their viability depends in no small degree on the perception that the debt is serviceable, and will be repaid.”
The UK’s Leave vote, therefore, cast shade on the market’s ability to do so. And while the event itself was unexpected, it now falls in step with a gathering trend of investors losing confidence in currency markets and ploughing their assets into safe haven assets.
How gold and currency markets differ
Gold and currency markets are generally affected by the same issues: political instability, civil unrest and commodity prices all have a bearing on prices, yet there are times when the two diverge. To give one example, the failed coup attempt in Turkey earlier this year sent gold prices tumbling, while forex markets stayed relatively stable.
Yet while gold has suffered a few blips in recent times, the precious metal has enjoyed a general upturn in fortunes over the past year or so. According to Adams: “The Brexit vote has been the most recent bullish event, as that caught the market off guard and has led central banks to increase liquidity and has forced the Fed to turn dovish again. Before that, the very disappointing US jobs report released on June 3 led to a $39 intraday rally but a more generally bullish factor has been the shift to negative interest rates across much of Europe and in Japan. Investors seem nervous about how central banks’ policies/experiments will pan out, especially given the massive amount of debt the world is now saddled with. Owning gold acts like an insurance against another crisis.”
In times of market turmoil, gold is often seen as a safe asset, and this sentiment could be seen in the hours after the UK’s decision to leave the EU was announced. The FTSE lost a frightening £120bn ($157bn) of its value, while the pound slumped to a 30-year low – and this is without taking into account the repercussions not just for those in Europe, but further afield. Markets in Japan fell by as much as eight percent, while an appetite for gold skyrocketed.
Unsurprisingly, investors have since rushed to buy gold, with its price edging ever closer to a three-year high. In the weeks after the referendum, the precious metal was worth over a quarter more per ounce than it was at the start of the year. However, this only continued for as long as uncertainty with regards to the pound, the prime minister and the prevailing sense of unrest remained a feature of the landscape.
Panning for gold
Not just the referendum but also the situation in the eurozone generally is playing into gold’s hands. Spanish, Italian and Portuguese bonds are all yielding very little in the way of returns, and a seeming inability to keep currencies on the straight and narrow is giving investors good reason to look elsewhere.
Pent up demand coming back to the market “after a couple of years of waiting for the right conditions”, according to Artigas, also means many investors have raised their strategic gold allocations. Price momentum likewise results in stronger flows from some investors who want to ensure they do not miss out on higher prices. These factors, again according to Artigas, “make gold a highly attractive liquid asset for those searching for returns with a low tolerance for risk”.
Far from the only factors propelling gold’s rise and rise, interest rates are equally as significant a factor in keeping the precious metal’s allure stable. Artigas continued: “Negative interest rate policies (NIRPs) in Europe and Japan have lowered the opportunity costs of holding gold. They have also limited the pool of assets many investors choose to access, resulting in more risk taking and also a greater need to balance that risk with assets like gold.” NIRPs have also limited the ability of the Fed to increase rates in the US, which in turn has slowed the appreciation of the US dollar, thus providing a respite for gold.
Interest rates are equally as significant a factor in keeping gold’s allure stable
While it has no yield of its own, gold has proven itself to be a sensible place to park investment in the event that cash or bonds fail to generate much in the way of returns. Any expectations the prevailing low interest rate environment would end were dashed in June when the Fed opted not to hike rates, and went further in showing little to no enthusiasm for doing so in the near future.
Google revealed only recently that the number of searches for the phrase “buy gold” spiked by 500 percent on hearing of the Bank of England’s decision to keep its rate unchanged at 0.5 percent. Higher rates, it seems, damage gold in the sense that they boost returns for rival assets and up the opportunity cost of holding what is essentially a zero-yield asset.
“NIRP, in addition to lowering the opportunity cost of investing in gold, has also resulted in an erosion of confidence in fiat currencies and increased market uncertainty, as investors grow more sceptical about the effectiveness of unconventional monetary policies”, according to Artigas. “In our view, all these issues together will result in a structural increase in gold demand from investors, as well as central bank reserve managers.”
Capitalising on reduced confidence
Continuing uncertainty derived from Brexit and the enduring low interest rate environment could advance gold’s impressive rise over the coming year. Oversea-Chinese Banking Corporation, for example, predicted a rise to $1,400 an ounce back in March, while Juerg Kiener, Chief Investment Officer of Swiss Asia Capital, told CNBC in July the price of gold could go on a prolonged rally and surpass its record level of $1,900 an ounce over the next 18 months.
Adams agreed with the sentiment that rising gold prices reflect diminishing confidence in currencies more generally, and an insurance against some unfavourable developments in the financial system. He told World Finance: “You could also argue that record high equities and bonds are encouraging investors to rotate some of their money out of those asset classes and into what have been the washed-out commodity sector. Gold is up, so are many of the industrial metals.”
Looking to the future, Adams maintained that, while there is reason to feel bullish in the medium term, the short-term outlook is not without its complications. Namely, “there is risk of a profit-taking sell-off, as the funds trading Comex have record gross and net long positions, so they are sitting on large unrealised profits that they may want to secure. Funds tend to trade short term, while ETF investors tend to have a longer time horizon”.
In short, the strength of the gold price is a reflection of the ongoing global market uncertainty, which, according to Artigas, “supports gold’s role as a highly-liquid asset that can mitigate risk and boost investment returns”.