Why the Precious Metal Shines the Most in 2019
Gold is one of the most unique commodities in the market. It has a long history as the first form of money. It then became the base for the gold standard which set the value for all money. Though as society evolved and the world abandoned the traditional gold standard, gold seems to lose its function in trades and appeals in investment. However, gold still confers familiarity. It creates a feeling of safety as a source of money that will always have value, no matter what, giving rise to its defensive nature. This year, amid the escalation of Trade War Tension and fluctuations in political climates, the world witnessed the rather lukewarm gold commodity market soar from 1270 USD/oz (01 May 2019) to the current price around 1500 USD/oz, gaining about 20% along the way. Such momentum in the gold is unparalleled. By having a vertical comparison, we could observe that the COMEX Gold price reached its highest point- 1542.60 USD/ oz- since 2011 and for the past two years 2018 and 2017, the annual change in COMEX gold price was -2.38% and +12.88% respectively. Comparing the COMEX index with S&P 500 performance for the past 6 months, the S&P 500 index had increased from 2945.83 (30 April 2019) to 3,036.89 (30 Oct 2019), gaining about 2.83%.
In general, investors buy gold for one of three reasons: a hedge, a safe haven, or a direct investment. To further illustrate this point, Many investors buy gold to hedge against the decline of a currency, usually the U.S. dollar. Gold also provides a safe haven that protects investors against a possible catastrophe. Last but not least, many private investors, as well as governments, want to take advantage of these tremendous increases in the price of gold because of its finite nature. Therefore, what are the factors behind the momentum of the rise of gold in 2019?
The first wave of increase in the gold price in May 2019 is likely to be catalysed by the worsening of Beijing-Washington relation. In theory, trade wars should be positive for gold prices. This is because trade wars hamper the economic growth – and the precious metals shine the most during slowdowns or recessions. The defensive nature of gold makes gold a perfect safe haven when as many investors are seeking protection against a possible economic collapse.
To give an example in history, in response to the eurozone crisis, the impact of Obamacare and the Dodd-Frank Wall Street Reform Act and the 2011 Debt Ceiling Crisis, gold prices skyrocketed in 2011, rising from $869.75 in 2008 to a record high of $1,895 on 5 September 2011.
Similarly, the trade war triggered a tumult in the Shanghai market on 6 May 2019 as the US-China Trade negotiation started to backlash. On 5 May 2019, Trump said that the US would increase tariffs on US$200 billion worth of Chinese products from 10 per cent to 25 per cent, effective Friday, May 10 and he would come up with new tariffs of 25 per cent on an additional US$325 billion worth of Chinese goods, which would cover essentially all remaining Chinese products. As a result, the Shanghai composite index plummeted by 5.58% in one day.
The intensified trade war created a bearish sentiment in the capital market as there was an increasing number of investors selling equities and buying gold to hedge against the systematic risks. From early May to the end of June, the gold market has soared by 9.74%.
Fed cut leading to weaker USD
It is commonly established that gold and the value of USD has a negative correlation. As a rule, when the value of the dollar increases relative to other currencies around the world, the price of gold tends to fall in U.S. dollar terms. It is because gold becomes more expensive in other currencies, and vice versa. Since the quantitative easing (QE) affects the value of USD in the forex market, it has an indirect impact on the gold market as well.
Theoretically, for countries with freely floating fiat currencies, as the central bank uses expansionary monetary policy to stimulate domestic consumption and investment, it will inevitably lead to hot money outflow, causing a depreciation in the exchange rate. Such an effect could even be intended as the US desperately needs to depreciate its currency to increase the export competitiveness amid trade wars.
Furthermore, the Fed interest rate cut sends out a signal that the US economic outlook would be bleak in the future, in spite of the historically low unemployment rate at about 3.7-3.5% and high consumer confidence. This is because it was the first time for the Fed to activate a hawkish expansionary monetary after 11 years since the 2018 Subprime Crisis. Besides that, it was also the first time that the Fed had 3 consecutive interest-cut in less than 3 months. Granted, the chairman of Fed Mr Jerome Powell said that the decision to lower rates was intended to “provide some insurance against ongoing risks. However, most investors reckon that a cyclical economic downturn is impending due to US President Donald Trump’s Hot-and-Cold Trade War and the tenuous economic outlook worldwide.
The uncertainties within the US economy led to a greater wave of depreciation. Traditionally, like gold, USD is perceived as a safe haven in an economically volatile world. Thus, the depreciation of the USD increases the appeal of gold. As shown in the diagram, rising fed rate-cut expectations have a direct correlation to the appreciation of gold as investors tend to use gold to hedge against the depreciation of USD.
Central banks make record $15.7bn gold purchases
Central banks is another factor that pushes the demand for gold this year. Institutions purchased a record $15.7bn of gold in the first six months of the year to diversify their reserves away from the US dollar as global trade tensions continue to simmer. Data released by the World Gold Council on August showed central banks, led by BRICS, bought 374 tonnes of gold — the largest acquisition of the precious metal on record by public institutions in the first half of a year. Central banks accounted for nearly one-sixth of total gold demand in the period (Financial Times, 2019).
The change in attitude towards gold since the financial crisis was highlighted by a European Central Bank decision to cease an agreement to limit sales of gold, as the region’s institutions are no longer selling it in large volumes and are instead now net purchasers.
Central banks could have different reasons for them to hold up to the rare yellow metal. Yet, the fundamental rationale is still the concern about the fluctuations in the forex market. BRICS countries always have a dominant presence in the gold market because traditionally China and Russia are intent to insulate themselves from a dollarized global economy, and gold seems to be a very important part of that strategy. For other countries, amid the trade tension between the US and China, they perceive USD as a less effective defensive currency as compared to gold because the USD might continue to depreciate to gain an advantage in international trade. Interestingly, Brien Lundin, editor of Gold Newsletter, suggested that when central banks are “buying as heavily as they are, it provides cover and a rationale for other central banks to do the same.” Thus, it led to a contagion effect among central banks worldwide.
Aside from the intensified trade wars, the political volatility in the Middle East created greater uncertainties, adding on to the safe-haven investment sentiment. The US economic sanction on Iran implemented in June 2019 particularly has a tremendous impact on the gold market, pushing up gold prices to a fresh six-year high. Gold broke the $1,430 mark for the first time since September 2013.
The sanctions on Iran not only make it illegal for U.S. people (including businesses) to trade with Iran but also severely restrict the use of any financial institution connected with U.S. banks or the U.S. financial system. (Forbes)
Such weaponization of economic tools led to an immediate negative impact on the Iran economy. The high risk of an impending war caused both the government and the people to store value and to skirt sanctions. In other words, even when payment through banks won't work, gold is frequently the last acceptable medium of exchange.
On top of that, this sentiment was compounded by the severe inflation problem within the country. As a result of decades of revolutionary Islamic governance and sanctions, the country bears more than 70% of the annual inflation rate, according to estimates from Steve Hanke, professor of applied economics at the Johns Hopkins University. The Iranian currency, the rial, is likely to continue to plunge thanks to the most recent US economic sanction, giving rise to the even higher inflation rate. The net demand for gold inside the country hence increases.
Till today, investors pay close attention to the fluctuations in the gold commodity market, though there are signs for detente between Beijing and Washington as both sides attempted to forgo some of the trade embargos. Uncertainties remain to a significant extent - the ambiguity of the Brexit outcome, the political and social instability of Hong Kong and the fickleness of Trump’s decision could continue to catalyse the risk-avoidance sentiments, pushing up the price of gold.