Gold can regain its shine


By Andrew Capon, for CME Group


  • Almost 80% of central bank reserve managers plan to increase their holdings of gold over the next year, according to a World Gold Council survey.
  • As the supply of new gold is severely limited, prices could reach new highs if inflation turns out to be persistent rather than ‘transient’

In the first half of 2021, achieving impressive investment results was only slightly more difficult than shooting fish in a barrel. Global equities and commodities posted their fifth best rolling six-month return in a century, with oil the best performer (up 51.4%). In contrast, 10-year US Treasuries fell 24% in the first quarter, marking their worst quarter on record.

Reflation transactions have paid off, but traditional inflation hedges have not. Gold fell 6.5% in the first half as investors, particularly in the United States, gave up their holdings of the precious metal. Outflows of $ 8.5 billion were recorded by US gold-backed ETFs. However, since then, the investment environment has become more nuanced. Asset allocation in the second half of the year could prove more difficult.

Fiscal policy factors in

The stimulus story reflected the success of the COVID-19 vaccination rollout, coupled with monetary and fiscal largesse. This combination led strategists to predict a V-shaped recovery as the global economy hit the reset button. Inflation numbers exceeded central bank targets, but 72% of investors in the Bank of America Global Fund Manager’s June survey believed repeated assurances from policymakers that inflation was “transient.”

In June and July, the US CPI recorded increases of 5.4%. In the eurozone, the PPI rose to a record 10.2% year-on-year. Monetarists will say that we are now seeing the lagged effects of an unprecedented stimulus. In April 2020 alone, America’s M3 (or broad currency) rose 7.3%, a figure higher than any full year in the previous decade. S&P reports that government spending has increased by the equivalent of 13% of global GDP.

Fiscal policy has become an important driver of aggregate demand. President Biden’s $ 1.4 trillion in infrastructure spending and the European Union’s $ 1,000 billion Green Deal are two examples. These initiatives require work. But just as inflation has been seen as transient, labor market pressures in the US and UK are seen as short-term and frictional.

The role of work

However, labor has an increasingly strong political voice. Supply chain bottlenecks in the wake of COVID-19 also suggest that the relentless rise in offshoring and globalization will slow. The Phillips Curve, which measures the relationship between prices, wages, and output fell into disuse in the 2000s. But labor compensation as a percentage of US GDP began to rise.

Has the “death” of the Phillips curve been greatly exaggerated?

Source: Federal Reserve Bank of Saint-Louis

If policymakers are wrong and inflation proves to be persistent, gold is likely to move up the asset allocation schedule for the remainder of 2021. The opportunity cost of owning gold (at zero yield) against 10-year U.S. Treasuries was only a decade below the height of the COVID-19 pandemic between February 2020 and 2021.

In August 2020, the price of gold hit new records, surpassing $ 2,000 per ounce. Overall, a quarter of all bonds still have a negative yield (German bunds up to 30 years) and only a third have a yield above 1%. India was eclipsed by Germany as the second largest retail market for gold in the first half of the year, but Indian investors are returning as COVID-19 slowly wanes. Current active cases there are at their lowest level since March 2020.

The latest Commitments of Traders report from the CFTC shows that short positions in gold (and silver) are being cut. Improving sentiment and shifting positioning look likely to provide short-term support for gold.

Supply and demand at a tipping point

Between 2001 and 2011, the price of gold fell from $ 225 per ounce to $ 1,906 per ounce. This was accompanied by a record of mergers and acquisitions ($ 38 billion in 2011) and a frenzy of capital spending. Since then, capital expenditure has fallen by 70%. Gold exploration budgets reached $ 10.8 billion in 2012, but gold discoveries (206 million ounces) peaked six years earlier. As of 2006, there are only a handful of new mines with potential reserves of over 6 million ounces. which entered service.

Cutting costs have forced miners to focus on brownfields, and existing reserves are quickly depleting. South Africa’s Witwatersrand Basin produced about 40% of all gold ever mined, but current production is about a tenth of its peak in the 1970s. The reserves of several of the world’s largest mines – Mponeng in South Africa, Carlin Trend in the US, and Super Pit in Australia – are in decline.

Mark Bristow, CEO of Barrick Gold, the second largest miner, said in August that “the chronic tendency of the gold mining industry to harvest the price of gold instead of investing in the future has led to a decline. reserves and a dearth of high quality development projects. . “

Perhaps the biggest support of all for gold is likely to come from central banks. At the turn of the century, the US dollar represented 73% of the reserves in the IMF’s COFER database. This figure has fallen to less than 60%. The share of the Chinese renminbi and the euro has increased modestly, but gold’s strong capital preservation characteristics allow reserve managers to sell their dollars while waiting to see if a real competitor to the US dollar emerges from the tough pack. .

The Bank of Thailand bought 90 tons of gold in April and May, increasing its holdings by 60%. The central banks of Brazil and Hungary have also been active, and Russia increased its holdings of gold in July for the first time since June 2020. Almost 80% of reserve managers plan to increase their holdings of gold over the course of next year, according to a poll. by the World Gold Council.

This long-term support for gold prices by central bank buyers could provide a floor above $ 1,700 as new supply is very limited. If inflation remains stuck above policy targets, asset distributors will be forced to reconsider gold’s traditional role as a hedge. This would help gold regain its luster and could drive up prices.

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