Can the gold rally hold?

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September 11, 2020

The price of gold has been on a tear since rebounding from a 10% decline in early March.1 While the metal has been known as a safe haven during times of economic stress, there’s more to its rally than that, according to Catherine Doyle, investment specialist on Newton’s Real Return team.

Before diving into why gold continues to rise, it should be acknowledged that its movement since March is historically expected. Its upward trajectory from the sell-off earlier this year resembles how the asset bounced back in the midst of the subprime mortgage crisis, Doyle says.

“Having initially been caught up in the sell-off, the precious metal has so far followed the 2008 playbook and has bounced back sharply making a new long-term high of US $1,976 a troy ounce at the end of July,” she says. “Its sharp price appreciation happened perhaps sooner than we would have expected but, when looking at the long-term drivers of the gold price, is not entirely unsurprising, indeed we consider that it has further to go.”

While low real yields in most fixed income assets have helped propel gold to new heights, Doyle says unprecedented monetary and fiscal stimulus from global central banks are key drivers in the rally’s continuation.

This is partially because when central banks, like the Federal Reserve, purchase long-term securities they ultimately decrease the overall supply and increase the value of those bonds. As a result, the yields on those assets go down. As central banks continue to provide liquidity to markets, as well as what Doyle labels as “ambitious spending plans by governments and evidence of Modern Monetary Theory in action through helicopter money,” gold’s price appreciation is only further justified.

Doyle also believes an eventual resurgence of inflation may help the asset climb to new heights. She says interest rates will likely stay at current lows until at least 2022, and possibly even longer due to debt servicing costs.

“Whereas previously inflation was notably absent in the real economy, despite trillions of dollars being pumped into the system through quantitative easing, this time the gloves are off in terms of spending as authorities go into overdrive trying to restore functioning capital markets and limit the degree of economic damage,” she says.

“While the initial effects of the crisis are undoubtedly deflationary in nature, it seems almost inevitable that inflation will in time resurge as governments around the world try and inflate their way out of an unprecedented debt burden.”

Despite many tailwinds, Doyle says technical signs may indicate that, on a short-term basis, the asset seems a little overbought, signaling it could be somewhat of a crowded trade. Although this does not diminish its attractiveness, she says, it does call for a little caution. And if there is another sell-off reminiscent of March, which Doyle says is unlikely, the Real Return team has tail hedges in place, through out of the money put options, which would help cushion their portfolio, she says.

However, for now Doyle believes the asset still holds an important role in portfolios. It serves as an effective hedge for a broad range of outcomes—including inflationary scenarios, currency debasement or tail events, she says. And besides, its rally may still have legs, she concludes.

1 CNBC: Gold rebounds as recent plunge opens door for bargain hunter. March 17, 2020



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