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Gold during the GFC vs COVID-19: Is it really just a repeat performance?

Topics [ market analysis financial crisis silver investing gold market gold investment silver market ]

Gold prices have continued their positive market run in Q2 2020, with the yellow metal trading above USD 1,700 per troy ounce.

The spread of COVID-19 and the economic fallout from steps taken to contain it have been major drivers of gold’s upward move as risk-conscious investors take steps to diversify their portfolios.

The last time the market experienced such huge global economic impact was during the 2008 Global Financial Crisis (GFC) when gold’s upward trajectory seemed to mirror what we’ve seen so far in 2020. 

This has led to speculation that gold’s current behaviour is essentially a repeat of its performance during the GFC. 

While there are certainly similarities between the gold market during both crises, there are also significant differences.

We explore these below.

Key similarities between COVID-19 and the GFC

1. Gold price movements 

Gold prices were strong leading into the GFC, suffered a correction as a liquidity crunch saw investors desperate to raise cash, and then rebounded. 

A similar dynamic is at play today. Gold prices shot higher after a dip in March 2020, down from record highs as the crisis escalated around the world. 

2. Demand for the precious metal

There is no denying a surge in demand for gold in recent months, with The Perth Mint recording its highest ever month for sales in April 2020. 

Sales also peaked during the GFC, with General Manager Minted Products, Neil Vance, commenting to The Canberra Times that “we have seen sales in the last two months that we haven’t seen since the Global Financial Crisis in 2008 and 2009.” 

3. Managed money activity 


Managed money, a means of investment whereby investors rely on the decisions of professional investment managers rather than their own, has seen a similar movement in activity during the two crises.

Managed money long positions rose from around 65,000 contracts to more than 200,000 contracts at the beginning of the GFC. Following the announcement of quantitative easing (QE) packages they dropped to below 63,000 before increasing over the subsequent 12 months to more than 225,000 contracts as spectators helped push the gold price up by more than 45%. 

Ahead of the global economic shutdown caused by COVID-19, managed money long positions rose strongly from just 80,000 contracts in November 2018 to almost 280,000 by late February 2020. Over the past three months they have again been pared back, dropping to just over 140,000 by 12 May 2020. 

4. Equity valuations

The Shiller CAPE price-to-earnings ratio shows that equities peaked at a price earnings multiple of around 30 in 2007.
 
Today, despite the sharp sell-off seen during the first quarter of 2020, the latest estimates suggest multiples are still sitting around 30. This is roughly the same valuation point seen before the more than 50% decline in equities during the GFC. 

History demonstrated that investors who hedged against the risk of a sharply falling equity market during the GFC strongly outperformed those who didn’t. 

There are no guarantees as to what the future holds, but there seems little reason to think those hedges are not needed in today’s COVID-19 environment. 

Differences between COVID-19 and the GFC

1. Health crisis complicates path forward

The nature of the COVID-19 threat itself indicates the potential for a different market outcome for gold to that seen in the aftermath of the GFC.

The GFC was a result of capital misallocation, excessive debt and over-reliance on the financial system itself. 

Challenging though it was, there was no public health threat complicating the policy response or the path out of the crisis. 

The as-yet unresolved health hazard has forced a policy response which has led to the economic fallout - but there is no way to legislate or print a vaccine into existence. There’s no denying the road forward is significantly more uncertain. 

2. Debt levels 

Total levels of debt, specially government debt, is another major difference. According to an April 2020 update from the Institute of International Finance (IIF), global debt levels have now topped USD 255 trillion and are sitting at more than 322% of GDP. 

That is some 40% higher than when the GFC hit. 

There’s no doubt public balance sheets are in a more overextended starting position today relative to a decade ago. 

3. Lower yields 

Yields are much lower now relative to the GFC. 

Across 2007 and 2008, US 10-year treasury yields averaged 4.10%. On 15 May 2020 the US 10-year yield was sitting at just 0.64%, a decline of almost 85%.

Cash rates, too, are the lowest they’ve ever been. Even during the worst of the GFC, the cash rate in Australia never dropped below 3%. Today’s cash rate is 0.25% and implied yields suggest there will be more easing to come. In the US, markets are now pricing in the arrival of negative interest rates by early 2021. 

At a portfolio level, the negative real yields on cash and vast swathes of the sovereign debt market combined with richly priced equity markets means prospective returns for diversified investors are far lower today than they’ve been in the past. 

This backdrop, combined with the fact that the opportunity cost of investing in gold is significantly lower in 2020 relative to the GFC environment, suggests gold should be well supported for some time to come. 

4. Monetary and fiscal policy more expansive

The fiscal response to COVID-19 is dwarfing what was deployed during the GFC. 

According to the statistics in this article, the fiscal deficit of all the nations highlighted (when weighted by each nation’s 2009 output) was 4.34% of GDP. The same measurement gives us a projected fiscal deficit of 7.34% of GDP in response to COVID-19. 

Government attitude to emergency monetary policy has also differed, with QE packages and zero interest rate policy (ZIRP) now standard elements of the monetary policy response kit. During the GFC, these stimuli were treated as extreme measures, to be used with caution and removed as quickly as possible.

Indeed, in the aftermath of the GFC, it took almost seven years for The Federal Reserve balance sheet to grow by USD 3.5 trillion to a pre-COVID-19 high of USD 4.52 trillion. This time around The Federal Reserve has added more than USD 3 trillion to its balance sheet in just over three months. 

5. Supply chain issues and trade uncertainty

Trade tensions and supply chain issues playing out in what may well prove to be a fragile geopolitical environment in the years ahead are another important distinction between the COVID-19 crisis and the GFC. 

In time, this will flow through to either lower company profits, higher inflation, or a combination of the two. These trends can be expected to support gold demand going forward. 

6. Commodity prices are much cheaper

Leading into the GFC, commodity prices were high, having outperformed stock prices for most of the early 2000s. The situation today couldn’t be more different. 

Even before COVID-19 hit, commodity prices were at the lower end of their historical range, having fallen approximately 75% from their record levels seen a decade earlier. 

Relative to stocks, they have never been cheaper. The S&P Goldman Sachs Commodity Index to S&P 500 ratio are comfortably below 1 today. When the GFC hit the ratio was more than 8, as shown in the chart below. 

 
Source: The Perth Mint, Reuters, au.investing.com 

Any investor who believes in ‘mean reversion’ will look at a chart like this and be encouraged by the potential for commodities to outperform in the decade ahead. 

7. Social impacts

Most investors are at least somewhat concerned at what the ‘post’ GFC world looks like, given it is characterised by ever-widening wealth inequality and political fragmentation.

COVID-19 has shone an even harsher light on the gap between the haves and the have-nots. This unease has fed higher gold demand. 

Summary

There are broad similarities in the performance trajectory of gold through both the GFC and COVID-19 crises and the market response in terms of demand for the precious metal.

However the differences in the macroeconomic, market and monetary sphere suggest wider implications for the asset’s future movements. 

The result is that the path toward economic recovery and the outlook for diversified investors is significantly more challenging today than it was just over a decade ago. 

This suggests that the outlook for gold is even more positive today, with demand likely to be more sustained as we navigate the uncharted territory of COVID-19. 

The article above was adapted from a more detailed analysis by The Perth Mint titled Gold: GFC vs COVID-19 and the inflation myth which was recently published on Livewire. For an in-depth study of the factors impacting gold during COVID-19 and the GFC, read it now.

The Perth Mint offers a range of precious metals storage solutions for investors who want the convenience and security of offshore storage. For further information please see perthmint.com/storage/


Disclaimer:
Past performance does not guarantee future results.
The information in this article and the links provided are for general information only and should not be taken as constituting professional advice from The Perth Mint. The Perth Mint is not a financial adviser. You should consider seeking independent financial advice to check how the information in this article relates to your unique circumstances. All data, including prices, quotes, valuations and statistics included have been obtained from sources The Perth Mint deems to be reliable, but we do not guarantee their accuracy or completeness. The Perth Mint is not liable for any loss caused, whether due to negligence or otherwise, arising from the use of, or reliance on, the information provided directly or indirectly, by use of this article.


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Perth Mint CEO shines light on Australian gold exports in live business broadcast

Topics [ financial crisis gold market ]

It was a case of lights, camera, action at The Perth Mint this morning as leading figures from Western Australia’s business community gathered to report on the State’s economic fortunes live on Channel 9.

Among the guests joining Today Perth News host Tracy Vo was Richard Hayes, CEO of The Perth Mint, who was invited to discuss the current strength of demand for Australian gold.

Mr Hayes said that The Perth Mint, which refines more than 90% of Australia’s annual gold mine output, was currently experiencing strong demand from China, the world’s leading destination for Australian gold exports.

“To give you some idea how that has increased in recent times, in 2011 we exported about 100 tonnes of gold to China,” he said. “Last year we did 230 tonnes of gold to China.”

“Our export numbers are about AUD17 to 18 billion a year and last year AUD11 billion went to China,” he said.


Richard Hayes, CEO of The Perth Mint, with Channel 9 interviewer Tracy Vo during today's live broadcast.

Mr Hayes added that investment was also fuelling demand for gold. Historically, demand for gold has increased at times of international crisis and upheaval.

“As people are looking to diversify their asset portfolios… gold is increasingly a commodity in which they are storing a portion of their wealth.”

“If you look at the world today… at geo-political instability, China, Russia, North Korea, what’s happening in the Middle East, gold is and always has been that ultimate store of wealth,” he said.

Others taking part in Channel 9’s business special from The Perth Mint’s gold exhibition were REIWA’s Hayden Groves; property valuer Gavin Hegney; Andrew Tomich of Hudson Recruiting; financial planner David Sharpe; James McGlew from Argonaut Securities; and Phil Thick from Tianqi Lithium.



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Message From Perth Mint Analyst Bron Suchecki

Topics [ gold investing financial crisis gold bull market gold prices gold bear market ]

CONFERENCES

Hi, Bron Suchecki here, precious metal analyst for The Perth Mint.

Gold and silver are at a crucial inflection point right now and if you want to know what the future holds then the 2015 Precious Metals Investment Symposium is a must-attend event.

The Symposium will be held in Sydney on 26 and 27 October and features a great speaker line up including John Butler (Amphora Capital), Keith Weiner (Monetary Metals), Nick Giambruno (Casey Research), Greg Canavan (Daily Reckoning) - and me, explaining Why hasn't the bullion banking system failed?

 

See this podcast interview about my talk.


Now in its 8th year, the Precious Metals Investment Symposium is the largest precious metals event in the Southern Hemisphere, bringing together every aspect of the precious metals investment industry from mining explorers and producers, to bullion companies and other investment products. I look forward to seeing you there - register online here.

Regards,

Bron Suchecki
MANAGER, ANALYSIS AND STRATEGY
THE PERTH MINT



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What Are The Origins Of The Terms 'Bull' And 'Bear'?

Topics [ financial crisis gold ]

FREQUENTLY ASKED QUESTIONS

Right now there’s much discussion about whether gold is headed for a bear market after its decade-long bull run. Time will tell, but the current debate may make you wonder how ‘bull’ and ‘bear’ entered the financial lexicon?

A bull is a boisterous, charging animal that throws its victim up in the air. A bear is slower, hibernates for long periods and is more likely to throw its quarry to the ground. Investopedia says these “actions are metaphors for the movement of a market. If the trend is up, it's a bull market. If the trend is down, it's a bear market.”

But the murky origins of the use of these terms suggest the explanation is probably not so straight forward.

One of the most frequently cited stories relates to bear skin jobbers in early 18th century London. In anticipation of falling prices, these middle men (or ‘bears’) sold their wares before the animals had even been caught - an early form of short selling. The contemporary proverb "don't sell the bear skin before you've killed the bear" highlighted the risks they ran.

This type of selling was also used by people involved in the South Sea Bubble, the share speculation mania that ruined many British investors in 1720. According to the Merriam Webster New Book of Word Histories, the scandal brought the term bear into widespread use.

Both bear-baiting and bull-baiting were popular blood sports at the time and from this it seems the bull was chosen to describe the opposite kind of trader. Just before the South Sea Bubble burst, poet Alexander Pope penned the lines: Come, fill the South Sea goblet full; The gods shall of our stock take care; Europa pleased accepts the Bull, And Jove with joy puts off the Bear.

In America, an attempt to corner the gold market in 1869 resulted in plunging gold prices and a stock-market panic. Reinforcing the symbolism, famous American cartoonist Thomas Nast portrayed dead bulls and a bear in a heap in front of a roped-off Wall Street with a sign reading This ‘Street’ is closed for repairs.

Today, New York’s renowned Charging Bull sculpture symbolises aggressive financial optimism and prosperity. Other notable sculptures include a bull and bear facing each other outside Frankfurt’s Stock Exchange (below).



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What Will The Price Of Gold Be In January 2014?

Topics [ financial crisis gold prices ]

WHAT OTHERS ARE THINKING

Just like Casey Research, we’d all like to know What Will The Price Of Gold Be In January 2014?

Despite being reluctant to make price predictions, Jeff Clark says it’s “hard to ignore the correlation between the US monetary base and the gold price.”

Since the start of the financial crisis in 2008, the “correlation coefficient is an incredible +0.94”, he states.

If the relationship holds (a distinct possibility given “QEternity”), then according to Jeff, gold could be $2,300 by the start of 2014 and easily be averaging $2,500 an ounce by year-end.

Link to full article here.



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Take Gold With You On Your Journey Into The Unknown

Topics [ financial crisis gold bull market gold prices ]

WHAT OTHERS ARE THINKING

FT Alphaville recently blogged on Deutsche Bank’s latest long term asset return study, subtitled A Journey into the Unknown.

The subtitle comes from the authors’ observation that “many economic or financial variables” are “now outside of any previous historical observations” reducing “confidence levels in predicting the future to fairly low levels.”

In their review of a number of assets (including gold), over different time periods, in various countries, over the last hundred years they note the unusual performance of gold since the US left the gold standard in August 1971. By way of example, consider this one comparison drawn from the table “Real Returns for US Assets over Different Time Horizons” (page 57):

 

Since 1900

Since 1971

10 Year Treasury

1.74%

3.77%

Equities

6.06%

5.44%

Gold

0.82%

4.90%

Since 1900 on an after inflation basis, equities outperformed gold by 5.24% but since 1971, gold is only down 0.54% compared to equities.

The authors note that gold’s equity-like after inflation performance post-August 1971 is “impressive considering that Gold over the very long-run and certainly up to 1971 was largely considered a store of value only and one that couldn't compete with riskier assets over the long-run, especially given its lack of income generation.”

This leads them to ask whether Global Financial Crisis (GFC) started on August 15th 1971, as the ending of dollar convertibility into gold meant that:

“…the shackles were off and countries no longer had to adhere to strict policies in order to defend their peg to Gold or to the Dollar. The era of global fiat currencies had begun and we moved into a new world order almost totally different to any that had preceded it. With nothing backing paper money, the path to almost unlimited credit creation had begun. … A combination of fiat currencies and ever weakening financial market regulation basically ensured almost unlimited credit and debt creation. It was surely inevitable that this money would end up somewhere and we therefore started a period of higher inflation than seen through history, and one where we saw frequent asset price bubbles all around the world.”

They note that in theory “the real price [of gold] shouldn’t have changed if published official inflation had responded to the post-1971 exponential credit, debt and money creation binge”, which leads them to suggest that possibly “Gold reflects the inflation in the monetary economy since 1971” whereas “CPI measures more reflect the prices of goods and services” (supressed downwards by China and cheap labour).

Gold’s 41 year “out-performance against inflation may as a minimum cast doubt on the quality of the inflation numbers” and leads them to ask whether gold is “the real inflation measure that we should benchmark all other assets” against or whether it has “been pushed towards bubble territory because of the system we have created.”

This indecisiveness continues in their analysis of potential future asset returns, assuming prices revert to their long-term mean. Their mean reversion calculations conclude that gold will have a negative return over the next decade of -7.8% (nominal) and -10.0% (real) and is thus “not a great real adjusted long-term investment from this starting point. We are basically close to 600 year highs!

However, they have “been long-term bulls of Gold given the money printing that we’ve felt will be necessary for many years to come and also the fragility of the financial system” and “given the work we’ve done in this study it’s fair to say that the world changed dramatically post 1971 and we wonder whether a long-term mean reversion for an asset like Gold now actually works.

Nevertheless, they come out in favour of accumulating “core, higher quality, real assets on dips. An income stream is also desirable. So higher dividend, quality equities remains the favoured traditional asset class of choice for us. Credit spreads hedged for an eventual rise in yields are also a decent safe haven investment.”

I consider it a bit odd that they did not see a stronger role for gold in an investor’s portfolio, given their judgement that:

  • money printing is here to stay across the globe until it eventually works and restores stability or it creates its own problems further down the line

  • inflation will win out as we haven’t seen a year of global deflation (using our median YoY measure compiled from 24 countries) since 1933 and

  • defaults, deflation and hyperinflation are still all possible in many parts of the world

Probably the strongest case for gold is their statement that “we are more reliant on our politicians and central bankers to manipulate and shape markets and returns than perhaps ever before. These are not free markets.” As George Bernard Shaw was quoted as saying, "You have to choose between trusting to the natural stability of gold and the natural stability and intelligence of the members of the government. And with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."



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