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Inflation fails to boost gold as precious metals fall


Precious metal prices suffered one of their largest monthly falls on record, with gold (-4.0%), silver (-10.5%), and platinum (-3.8%) falling sharply in US dollar terms. Rising real yields, a strong US dollar, expectations of a taper from the US Federal Reserve, and fallout from the Evergrande crisis in China, all contributed to the move, with gold now down close to 15% since the peak in August last year.

Summary of market moves

• Gold prices fell sharply during September, with the precious metal at one point falling toward USD 1,700 per troy ounce and ending the month down 4% in US dollar terms.

• Silver was hit even harder, falling by more than 10%, with the price dropping toward USD 21 per troy ounce.

• A declining Australian dollar, which ended September down almost 2% versus the US dollar mitigated losses for Australian investors, and saw gold finish the month just above AUD 2,400 per troy ounce. 

• The pullback in gold has now seen the precious metal fall 15% since the highs in August 2020, with some now going so far as to question whether the precious metal has lost its status as a trusted inflation hedge.

Full report – September 2021

Precious metals were particularly volatile during September with gold (-4.0%), silver (-10.5%), and platinum (-3.8%) all falling sharply in US dollar terms, despite a rally to close out the month.

The declines in gold and silver, which saw the metals finish September just below USD 1,750 and just over USD 21.50 per troy ounce respectively, were among the sharpest monthly falls seen in the last three years, a period in which the two precious metals have increased by close to 50%.

Volatility was not confined to the precious metals space, with equities, commodities and fixed income markets also seeing large moves, driven by continued uncertainty regarding COVID-19, the challenges facing Evergrande and the broader Chinese property market, and expectations of tapering from the US Federal Reserve.

Focusing in on the precious metal space, several factors contributed to the weak price action, including:

• Higher real and nominal rates: 10-year treasury yields climbed above 1.50% in nominal terms, while in real terms they also increased from -1.03% to -0.85% in September.

• Continued appetite for risk assets: Despite the pullback seen in equities during the month, investors still have a strong appetite for risk assets, with the S&P 500 for example up by more than 15% this year.

• US dollar strength: The US dollar continued to march higher in September, with the Dollar Index (DXY) up almost 2% to trade above 94, the highest level seen in this calendar year.

• Fund positioning:  Speculative investors cut back their long exposure in the gold futures market, with gross longs down by 12.5% from just over 136,000 contracts at the end of August, to just below 119,000 contracts by late September. Short positions, meanwhile, increased by 60% from 54,878 to 88,062 contracts over the month.

Given this backdrop, it’s no surprise that sentiment towards precious metals has also soured, with a range of bearish headlines dominating the news in the last month.

These include “How gold let me down, and other investing mistakes this year”, an article quoting high profile special purpose acquisition company (SPAC) investor Chamath Palihapitiya, who proclaimed Bitcoin has effectively replaced gold, and countless articles suggesting precious metals will see more short-term downside.

While there is nothing wrong with the articles per se, and in the short-term there are still bearish forces at work, the very fact gold is getting such bad press right now could be seen as an indicator that prices are close to bottoming.

Nowhere is this more evident than in the recent commentary surrounding gold and its status as a trusted inflation hedge, which many are beginning to doubt, given the correction in the gold price has occurred alongside a period of much higher consumer price inflation (CPI) readings in the United States.

We explore in detail below.

Gold and inflation: what you need to know

• Gold has fallen despite the rise in inflation during 2021.

• Gold has performed strongly across longer periods of higher inflation.

• Gold doesn’t need high rates of inflation to perform well.

• Gold is likely to benefit going forward if the inflation spike lasts longer than expected.

Ask most investors about gold and irrespective of whether or not they have exposure to the precious metal, most will acknowledge that it’s a store of value over the long-term, and that it’s a good inflation hedge.

The belief that gold helps to protect against inflation is understandable, given the precious metal has maintained its purchasing power across the centuries, something truly appreciated by those whose fiat currencies lost most if not all of their value.

In more modern times, gold has also served to protect wealth through periods of higher inflation, most notably throughout the 1970s, with the following table highlighting average annual returns for gold in high (>3% p.a.) and low (<3% p.a.) inflation environments across the past 50 years.

 Average annual US dollar spot price performance of gold (%)


Despite this track record, a close to 15% correction in the USD price of gold since August last year, which has occurred despite consumer price inflation (CPI) rates rising to more than 5% p.a. at present, has many questioning whether the precious metal has lost its status as a trusted inflation hedge.

Why hasn’t gold moved higher with inflation in 2021?

Apart from the fact that gold rallied by approximately 70% between Q3 2018 and Q3 2020, there are several factors that have held the precious metal back in 2021.

These include a firmer US dollar, with the dollar index (DXY) up around 4% this year. Meanwhile, equities have enjoyed one of their strongest runs on record, with the S&P 500 almost doubling since the March 2020 low, supported by inflows into global equity funds in the first half of 2021 that were on track to exceed the total value of inflows seen in the prior 20 years combined.

There is also the fact that the overwhelming belief in the market today is that the recent spike in inflation is likely to prove transitory, with headline CPI increases being driven higher by a small subsection of the inflation basket.

Whether this proves right or wrong remains to be seen, though the chart below, which plots annual changes in headline CPI, as well as median and trimmed mean CPI, helps explain why the market is willing to give to the transitory narrative the benefit of the doubt for now.

 US inflation indicators


Source: Cleveland Federal Reserve

Gold made a huge move in 2020

Perhaps a bigger part of the reason gold has disappointed investors in 2021 is that it made such a big move in the first nine months of last year.

This can be seen in the table below, which shows a handful of key variables at the end of 2019 and each quarter of 2020.

Market indicators during 2020

Source: Federal Reserve, World Gold Council, Cleveland Federal Reserve, US Treasury, St Louis Federal Reserve

Looking at the table we can see that:

The Federal Reserve balance sheet increased by more than USD 3 trillion across the first six months of 2020.

Real yields on 10-year US treasuries fell by more than 1% in the first three quarters of 2020.

• 10-year breakeven inflation rates bottomed out in Q1 2020, well ahead of short-term CPI numbers.

Given this backdrop, it is no surprise the gold price was up by more than 30% at one point in 2020, even though the official year on year change in headline inflation was below 2%.

So, while its true gold hasn’t been a very good inflation hedge in 2021, that’s coming off the back of a year that the precious metal recorded one of its strongest gains on record.

Ultimately, perhaps what the data is telling us is that if you have to wait for the official statistician to tell you inflation has arrived, then you’ll pay a much higher price to buy inflation protecting assets.

Gold doesn’t need high inflation to prosper

It’s important to note that while high inflation is typically conducive to higher gold prices, the precious metal doesn’t need high rates of inflation to prosper.

This is evidenced in the chart below, which shows the USD gold price, annual changes in CPI, and average inflation rates across the past five decades.

Gold and US inflation data since 1970


Source: World Gold Council, St Louis Federal Reserve

The chart makes it clear that gold rose very strongly in the first decade of the new millennium, even though inflation rates were declining relative to rates of price growth seen in the 1980s and 1990s.

The table below provides more detail on this, highlighting annualised inflation rates and gold price returns over each of the last five decades. 


Gold and US inflation data by decade 

       

Source: World Gold Council, St Louis Federal Reserve

Be it stock market volatility, geopolitical uncertainty, recessions or global pandemics, there are clearly a range of other factors that can and do influence gold at various points in the investment cycle.

Gold and the inflation backdrop today

An argument can be made that the market’s view of inflation today looks somewhat similar to just over 10 years ago, in the period leading into the Global Financial Crisis (GFC). 

This can be seen in the following chart, which shows the gold price, as well as the percentage gap between current inflation rates and the 10-year breakeven inflation rate expected by the market.

Source: Cleveland Federal Reserve, St Louis Federal Reserve, World Gold Council

The chart highlights that at present, there is an almost 3% gap between current annual CPI (+5.25%) and the 10-year breakeven inflation rate (2.35%). This has not been seen since Q3 2008.

Interestingly, gold prices fell by approximately 20% back then, from just below USD 1,000 per troy ounce, to just below USD 750 per troy ounce. As we all know, the precious metal then went on to rally for the next three years, with the market ultimately topping out more than 150% higher at close to USD 1,900 per troy ounce in 2011.

This time around we’ve seen a similar pullback, with gold dropping by approximately 18% between August 2020 and the low from this cycle seen in April 2021, when gold temporarily traded back below USD 1,700 per troy ounce.

And while no one can be certain if history will repeat or even just rhyme, there is a range of factors suggesting gold could be well supported going forward, including:

• Central bank and fiscal largesse: The post GFC environment was characterised by central banks reluctantly adopting QE, ZIRP and other forms of unconventional monetary policy, and promising to walk it back at the first opportunity. Despite talk of the Fed tapering in late 2021, the post COVID-19 environment sees central banks largely reticent to abandon expanded stimulatory measures, with a much greater focus on full employment, an embrace of average inflation targeting, and the adoption of MMP (modern monetary practice) through the de facto monetisation of federal deficits.

• Trimmed mean inflation rising: While headline inflation rates may ease, there is clearly an increase in underlying pricing pressure building, with the trimmed mean inflation measure now comfortably above 3% per annum.

• Supply side shocks: Whether it’s a shortage of fuel in the UK and across Europe, industry shutdowns in China, or continued bottlenecks in global supply chains, issues on the supply side look like they’ll add some upward price pressure well into 2022.

It’s also critically important to note that the market expects the recent spike in inflation to be transitory and has largely priced this in already. As such, even if headline CPI rates decline in the months ahead, they’re unlikely to hurt precious metals. If the recent inflation spike proves not to be as transitory as currently expected, then there is a good chance we’ll see a surprise to the upside when it comes to the gold price going forward.

Combine this with a current environment that sees sentiment toward gold near all-time lows, and we have the potential makings of a market bottom playing out in front of us right now.


Disclaimer:
Any opinions expressed in this article are subject to change without notice. The information in this article and the links provided are for general information only and do not contain all information that may be material to you making an investment decision. The Perth Mint is not a financial adviser and nothing in this article constitutes financial, investment, legal, tax or other advice.  Before making an investment decision you should consider whether it is suitable for you in light of your investment profile, objectives, financial circumstances and the merits and risks involved. 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 have not been independently verified by The Perth Mint and we do not guarantee their accuracy or completeness. The Perth Mint does not accept any liability, including without limitation any liability due to any fault, negligence, default or lack of care on the part of The Perth Mint., for any loss arising from the use of, reliance on, or otherwise in connection with the information contained in this article.



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Diversify or let your winners run? How to encourage your portfolio to bloom

There is no shortage of investment information and tips for investors looking to grow their portfolio. The challenge is how to turn them into actionable insights that work for the individual, something that is made even harder by the fact that while many of these tips make sense as standalone concepts, they can conflict with each other.

Consider the fact that many investment advisers talk of the need to have a diversified portfolio, which is another way of saying don’t put all your eggs in one basket. Those who embrace diversification fully expect that at any point in time they’ll have some exposure to asset classes that are rising in value, and some that are falling.

There is nothing wrong with this approach, and indeed investment legend, Nobel Prize laureate and founder of Modern Portfolio Theory, Harry Markowitz, once described diversification as “the only free lunch in finance”.

Meanwhile, other famous investors talk of the need to give outperformers room to grow while cutting losses in underperforming assets. Indeed, none other than Warren Buffett was fond of saying selling your winners and holding your losers is like cutting the flowers and watering the weeds, though it’s not his quote originally.

In practice, disciples of this school of thought believe in concentrated portfolios as the best way to build wealth.

These two arguments – diversification versus letting your winners run, are to some degree in conflict with each other.

As to which one is ‘right’, Buffett’s view makes a lot of sense in the context of owning a particular stock, but from an asset allocation perspective, which is the primary driver of diversified portfolio returns, one could argue it doesn’t.

After all, history is very clear that markets move in cycles, and asset classes that see years of outperformance (the flowers) eventually run out of steam and turn into losers (the weeds).

What is an investor to do?

Below we look at three hypothetical portfolios comprised of just two asset classes, equities (using the S&P 500 to proxy returns) and gold, highlighting the returns and risks over a 50-year time period from 1971 to 2020.

Note that we’ve used a starting balance of $10,000 evenly split between the two asset classes, with the three portfolio simulations as follows:

• Never rebalancing the portfolio.
• Rebalancing back to 50% allocations each year.
• Rebalancing back to 50% allocations each decade.

The table below highlights the results, from both a return and risk perspective for the three portfolios.

Equity and gold portfolio statistics – 1971 to 2020


Source: The Perth Mint, LBMA, NYU Stern

The table makes it clear that the pure buy and hold approach is the lowest returning strategy of the lot, generating returns of just under 10% per annum over the past five decades.

The portfolio that embraces annual rebalancing is the second-best performer, generating returns of just over 10.5% per annum, and also exhibits much lower volatility than the other two portfolios.

This is because the annual rebalancing back to a 50% weight to each asset (in practice selling a bit of last year’s flowers and buying a bit of last year’s weeds) means the maximum allocation it ever has to either asset class is much lower than the other two portfolios.

This can be seen in the chart below, which looks at the allocation to gold for each portfolio over time. Note how the portfolio that rebalances once a decade, and the portfolio that never rebalances, had maximum gold allocations of almost 90% by the end of the 1970s, and just over 10% towards the end of the 1990s. The portfolio that rebalances every year never gets to those extremes.

Gold weights as a percentage of total portfolio assets – 1971 to 2020

Source: The Perth Mint, LBMA, NYU Stern

So while the portfolio that never rebalances, and the portfolio that rebalances every year, both had their worst calendar year in 1981 (primarily driven by a 32% fall in gold), the latter portfolio fell by only 18.6%, versus an almost 30% dip for the portfolio that never rebalances.

The portfolio that rebalances every decade is by far the best performer of the three, with annual returns of almost 13% per annum. In many ways this makes sense, as it allows market cycles time to play out, giving the flowers 10 years to grow, and the weeds 10 years to shrivel, before rebalancing the portfolio.

The difference in terms of total dollar value gained from this portfolio relative to the others is staggering when compounded over five decades.

Interestingly, the portfolio that rebalances every decade is not only able to achieve returns that are 3% per annum higher than the portfolio that never rebalances, but also displays lower overall portfolio volatility, and had a worst year that is essentially in line with the portfolio that rebalances annually. 

These findings suggest there is value in adopting a hybrid approach between letting your winners run and aiming for a diversified portfolio.

After all, if you never rebalance, you’ll end up with a portfolio too heavily weighted to last year’s, or last decade’s winning asset. You will then suffer when the tide turns against that asset.

Conversely, if you always rebalance, you aren’t giving your flowers any real time to grow, with investment cycles needing years to fully play out. That can clearly cost you substantial returns over the long run.

Limitations of the study

Backwards looking exercises in portfolio modelling are by definition limited. There are four primary factors which the above model doesn’t account for, all of which would impact the total return from each of three portfolio simulations. They are as follows:

• Inflation: In the past 50 years, inflation has averaged just below 4% per annum. This would obviously negatively impact the real return generated by all portfolios.

• Taxes: Tax on the income stream generated from dividends, plus any capital gains from sales of gold and equities, will also diminish total returns.

• Transaction costs: The more you trade, the more you pay in brokerage fees and/or buy sell spreads.

• Management or storage fees: There is typically some kind of fee paid for holding any kind of investment, which will also impact total returns.

Last but not least, these portfolios exist only on a spreadsheet. They don’t take the risk profile, or psychology of an investor into account.

For example, in the portfolio that rebalances every decade, the allocation to gold by the end of the year 2000 was just 12%. That’s because the 1990s was one of the best decades on record for equities, with average annual returns of more than 20%, while gold languished. The headlines at the time were proclaiming the precious metal was dead and that the stock market was certain to head ever higher.

Hindsight proved it was a wise choice, but how many people in the year 2000 would have felt comfortable selling almost half of their equity portfolio and using the proceeds to buy gold.

What to do now?

The example above of an investor selling down the equity component of their portfolio and using the proceeds to buy gold is arguably just as relevant today as it was 20 years ago.

This is because the last 12 months, and indeed the last 10 years, have seeing equities strongly outperform gold, evidenced in the below chart, which highlights the rolling 10-year performance differential between the S&P 500 and the precious metal.

From an asset allocation perspective, this means the gold portion of the portfolio that aims to rebalance every decade was just 27% by the end of last year, which can be seen in the table below.

That’s not quite as low as it was at the end of 1990 or 2000, but it is clearly a lot closer to those levels compared to the more than 80% allocations to gold this portfolio held by 1980 and 2010, which were at or near the top of long bull markets in the precious metal. 

On a relative basis at least, this suggests that gold is cheap today.


Disclaimer:
Any opinions expressed in this article are subject to change without notice. The information in this article and the links provided are for general information only and do not contain all information that may be material to you making an investment decision. The Perth Mint is not a financial adviser and nothing in this article constitutes financial, investment, legal, tax or other advice.  Before making an investment decision you should consider whether it is suitable for you in light of your investment profile, objectives, financial circumstances and the merits and risks involved.  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 have not been independently verified by The Perth Mint and we do not guarantee their accuracy or completeness. The Perth Mint does not accept any liability, including without limitation any liability due to any fault, negligence, default or lack of care on the part of The Perth Mint., for any loss arising from the use of, reliance on, or otherwise in connection with the information contained in this article.



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Volatile month for precious metals as gold turns 50

a gold bear with blue arrows

Gold prices displayed heightened volatility during August, with a large sell off seen early in the month before the precious metal staged a recovery to close back above USD 1,800 per troy ounce. Silver was also impacted, at one point falling by almost 10% intra-month, though it too finished on a stronger footing. Despite the volatility, a range of factors look set to support precious metal markets going forward. 

Summary of market moves:

• Precious metal prices were particularly volatile during August, with gold ending the month falling by almost 1%, while silver fell by almost 6%. 

Equity markets continued to rally, with the S&P 500 closing above 4,500 points at the end of August, up almost 3% for the month. The ASX200 was up 2% during August.

Cryptocurrency prices continued their recent recovery, with Bitcoin ending the month trading just below USD 47,000, up almost 10%.

The Australian dollar continued to weaken, falling almost 1% versus the US dollar, driven by falling iron ore prices and continued uncertainty caused by lockdowns along the Eastern seaboard. 

The spread of the COVID-19 Delta variant continued to plague the global economy, with central banks, including the US Federal Reserve, which just completed its annual Jackson Hole Symposium, likely to provide significant levels of monetary policy stimulus for the foreseeable future.

August 2021 marked 50 years since the United States ended convertibility of the US dollar into gold, with the precious metal subsequently playing a valuable role in investment portfolios over the past five decades.

Full report - August 2021

Volatility in precious metal markets picked up during August, with gold and silver prices at one point falling 8% and 9% respectively in US dollar terms. The two precious metals then rallied as August came to a close, with gold recovering almost all its losses to trade back above USD 1,800 per troy ounce, down just 1% for the month as a whole.

Silver finished the month trading back above USD 24 per troy ounce, down 6%, with daily movements in prices throughout August seen in the chart below.

a graph depicting the gold and silver price movements

The sell-off that occurred in early August, which can be seen in the above chart, was driven by a rapid liquidation that took place in the gold futures market on the morning of Monday 9 August.

In the space of one hour, more than 35,000 gold contracts (with a notional market value of over USD 6 billion) were traded, with more than half of the turnover happening in one 15-minute time slot. In that window prices fell 4% from USD 1,755 to USD 1,677 per troy ounce.

While much speculation has taken place as to what drove that level of turnover in such a short time frame, the data makes it clear that the market hit an air pocket of sorts, with the drop driven predominantly by a short-term lack of liquidity. The fact that gold recovered a good part of the losses within the day reinforces this view.

Indeed, the sharp sell-off seen on 9 August may end up marking the completion of the corrective cycle in gold, with the metal rallying more than 8% since. Multiple factors have driven the rally, including:

• The threat posed by the COVID-19 Delta strain, with the daily case rate in the United States back above 150,000 and continuing to surge, despite the fact almost 65% of the adult population has been fully vaccinated.

• Heightened geopolitical tension in the wake of the withdrawal of American and other coalition troops from Afghanistan.

• A continued dovish tone from the US Federal Reserve, with Chairman Jerome Powell using the annual Jackson Hole Symposium to reassure markets the Fed is in no rush to begin tapering asset purchases, let alone normalise monetary policy in any meaningful sense. 

The speech from Powell noted that while the US job market was recovering, there was still a long way to go. He also reiterated the Fed’s view that the recent spike in inflation will prove transitory (more on this below, where we discuss whether or not gold remains an inflation hedge).

It was enough to boost stock markets, cause a fall in the US dollar, and ultimately, help boost gold back over USD 1,800 and silver back above USD 24 per troy ounce as August came to a close. 

Is gold still an inflation hedge?

Five decades of market data tells us conclusively that gold tends to perform well during periods of higher consumer price inflation (CPI), with average annual increases in excess of 15% per annum in the years CPI rates are 3% or higher.  

However, given gold has been in a corrective cycle since peaking above USD 2,000 per troy ounce in August last year, and given this time period has coincided with an uptick in CPI,  questions about whether gold is still an inflation hedge continue to be asked in financial blogs, podcasts etc.

We are encouraged by the very fact this question is getting airtime, as it’s the kind of thing you only see when sentiment toward gold has soured and when prices have eased, which is often a good time to be buying.

As we highlighted last month, there are multiple factors that have contributed to gold falling in the last year despite the uptick in inflation - from soaring stock prices to the market’s belief that the current surge in inflation will prove transitory.

This month we want to delve a little deeper, looking at the difference between current annual rates of CPI, and the market’s expectation for average inflation over the next 10 years (called the breakeven rate). As per the table below, there is now a 3% gap between current CPI, which was 5.4% in July, and the 10-year breakeven rate.

table depicting the annual change in CPI

The chart below, which dates back to 2003, shows the difference between these two readings on a monthly basis, as well as the gold price itself over the same time period.

graph depicting annual CPI minus 10 year breakeven inflation rate and us dollar gold price

The standout observation from the chart is that the inflation differential between CPI levels and the 10-year breakeven rate, which is 3% right now, is as pronounced as it was back in Q3 2008, around the time the Global Financial Crisis hit.

History shows that equities fared horribly in the period that followed, falling by 40% over the next six months. Gold, on the other hand, went from strength to strength, rallying by more than 100% in the three years that followed.

The chart, and the fact the market doesn’t think that the current high rates of CPI will last, is encouraging for another reason. Markets don’t react to formal data releases like CPI, GDP, or employment figures - they react based on what a data release is relative to what the market expected the data release to be.

As such, even if inflation rates do ease in the months ahead, it may not negatively impact gold at all, as the market already expects this to happen.

Billionaires are bullish gold 

For those unfamiliar with the name, John Paulson was one of the few investors that not only foresaw the problems in the US housing market that would culminate in the sub-prime crisis and the GFC, but also put his money on the line, making billions of dollars in the process.

He has also long been a fan of gold, with the below extract from a recent interview with Bloomberg (subscription required ), highlighting his current view on the precious metal.

Bloomberg: “After you made your famous trade, you bought a lot of gold, or gold futures, and you were called by some a gold bug. Gold’s now about $1,700 an ounce. Do you think that gold is a good investment at this price?”

Paulson: “Yeah, we do. We believe that gold does very well in times of inflation. The last time gold went parabolic was in the 1970s, when we had two years of double-digit inflation.

The reason why gold goes parabolic is that basically there’s a very limited amount of investable gold. It’s on the order of several trillion dollars, while the total amount of financial assets is closer to $200 trillion. So as inflation picks up, people try and get out of fixed income. They try and get out of cash. And the logical place to go is gold. But because the amount of money trying to move out of cash and fixed income dwarfs the amount of investable gold, the supply and demand imbalance causes gold to rise.”

Bloomberg: “So, you’re a big believer in gold as a good investment now?”

Paulson: “Yes. We thought in 2009 with the Fed doing quantitative easing, which is essentially printing money, it would lead to inflation. But what happened was while the Fed printed money, at the same time they raised the capital and reserve requirements in banks.

So, the money sort of recycled. The Fed bought Treasuries, created money, which wound up in the banks and then was redeposited at the Fed. And the money never really entered the money supply. So, it wasn’t inflationary. However, this time it has entered the money supply. The money supply was up about 25% last year and the best indicator of inflation is money supply. So, I think we have inflation coming well in excess of what the current expectations are.”

Paulson isn’t the only high-profile investor singing gold’s praises, with Mark Mobius, who spent the better part of 30 years managing emerging market portfolios, and once served as the executive chairman of Templeton Emerging Markets Group, recently stating investors should hold up to 10% of their portfolios in gold.

Like Paulson, Mobius sees the value in holding gold given the potential for significant currency devaluation in the years to come. 

Gold turns 50

August 2021 marks the 50-year anniversary of the closing of the “gold window”, with then US President Richard Nixon ending the convertibility of the US dollar into gold. Since then, the price of gold has risen by approximately 8% per annum, outperforming a range of traditional asset classes over this period.

Alongside the strong long-term returns, gold has also offered investors:

• An effective equity market hedge and portfolio diversifier, with gold typically being the best performing asset whenever equity markets suffer their most significant corrections.

• Protection from monetary uncertainty, with gold delivering positive real returns in periods of high inflation, and in periods of low inflation.

• Accessibility, with gold being an asset class that every investor can include in their portfolio, irrespective of their budget.

We discussed some of these themes in significant detail in a separate blog post published to commemorate the 50 years since Nixon’s momentous decision.

While none of these attributes guarantee what will happen to the gold price from one day to the next, in time they can all be expected to support gold demand, and therefore prices, especially given the continued uncertainty plaguing the global economy, the monetary environment we are in, and how expensive financial markets as a whole are.

For this reason, we remain optimistic on the outlook for gold over the medium to long-term and why we think that alongside silver it will continue to play an important role in diversified portfolios.

Jordan Eliseo
Manager – Listed Products and Investment Research
The Perth Mint
September 2021

Disclaimer:
Any opinions expressed in this article are subject to change without notice.The information in this article and the links provided are for general information only and do not contain all information that may be material to you making an investment decision.The Perth Mint is not a financial adviser and nothing in this article constitutes financial, investment, legal, tax or other advice.  Before making an investment decision you should consider whether it is suitable for you in light of your investment profile, objectives, financial circumstances and the merits and risks involved.  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 have not been independently verified by The Perth Mint and we do not guarantee their accuracy or completeness.The Perth Mint does not accept any liability, including without limitation any liability due to any fault, negligence, default or lack of care on the part of The Perth Mint., for any loss arising from the use of, reliance on, or otherwise in connection with the information contained in this article.



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Lost decades and half-centuries: gold turns 50


“I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.”

– US President Richard Nixon – 15 August 1971

Executive Summary

    • It is 50 years since the United States severed the link between the US dollar and gold.

    • Gold has performed strongly as an investment asset over this entire time period, and has outperformed stocks, bonds and cash since the turn of the century.

     • While gold has lagged risk assets in the last decade, a range of metrics suggest the precious metal may fare much better in the years ahead. 

Full article

Despite the challenging path that US dollar gold investors have had to tread in the last decade, the 50-year anniversary of the closure of the ‘gold window’ represents a perfect time to take stock of the precious metal and its attributes as an investment.

On Sunday 15 August, we marked five decades to the day since then US President Richard Nixon made the above statement in a televised address to the nation on a Sunday night while markets were closed.

Many market historians would argue Nixon had little choice but to follow this course of action. Rising inflation throughout the 1960s had seen foreign governments line up to exchange their US dollar denominated assets for physical gold, with total US gold reserves dropping from over 20,000 tonnes in the mid-1950s to less than 10,000 tonnes by the end of 1970.

Irrespective of one’s view as to why this change was enacted, five decades later it’s clear that the suspension of the convertibility of the US dollar into gold has proved anything but temporary.

Since that day, the price of the precious metal has risen from below USD 40 to more than USD 1,750 per troy ounce at the time of writing. This works out to be as an annualised increase of just over 8%, with the return on gold and a range of traditional asset classes over multiple time periods to the end of 2020 highlighted in the table below.

Asset class returns (% per annum)


Despite the strong gold rally in the past five years, the market leading returns since the turn of the century, and a macro environment that many would expect to be favourable, it’s been a somewhat unhappy 50th birthday for the precious metal, with gold prices having fallen more than 5% in US Dollar terms this year.

This includes a dramatic sell off on Monday 9 August, which saw an almost USD 100 per troy ounce drop in a matter of minutes as more than 17,500 gold futures contracts (worth approximately USD 3 billion) were dumped into thinly traded markets, rattling the confidence of some gold market bulls.

In this article we’ll explore:

  • Why gold has fallen in 2021 and why it hasn’t responded to higher inflation.
  • Why gold has experienced a ’lost decade‘ in US dollar terms.
  • What 50 years of price action tells us about the role of gold in a portfolio.
  • Why the coming decade may be far more rewarding for bullion investors.

Why isn’t gold responding to the recent spike in inflation?

Between August of 2020 and July 2021, the Consumer Price Index (CPI) in the United States rose from 1.31% to 5.4% annualised. Despite the sharp increase, gold, which many expect to prosper when inflation is rising, has fallen by approximately 15%.

There are a multitude of factors which help explain this decline, from rising economic optimism as COVID-19 vaccines have been rolled out across most (though clearly not all) of the developed world, to an increase in the value of the US dollar, and a stabilisation/increase in real yields at the medium to longer end of the curve.    

Perhaps more important than any of the above factors though are the following three:

Momentum exhaustion

It’s important to remember the gold price was trading below USD 1,200 per troy ounce in September 2018. In the two years that followed, the precious metal rallied more than 70%, culminating in the all-time high above USD 2,050 per troy ounce in August 2020.

With the exception of the super spikes in gold seen in the middle and at the end of the 1970s, the rally in the aftermath of the Global Financial Crisis (GFC) and the run up to the 2011 price peak, that 70% rally was one of the largest two year price moves seen in gold across the past five decades.

Irrespective of the asset class and the direction it’s heading in, momentum eventually kills itself. One could also argue part of gold’s rally in the first half of 2020 represented the market pricing in some of the expected increase in inflation, before it began to show up in official CPI readings.

Equity market strength

Despite the continued threat posed by COVID-19 and the uneven nature of the economic recovery, Wall Street is partying like a bachelor in Las Vegas, with the S&P 500 only a couple of percentage points away from doubling off the March 2020 low.

Strong earnings, a supportive (to say the least) monetary environment, and a lack of real yield in traditional defensive assets, has seen a veritable wall of money flow into risk assets, with research from Bank of America suggesting USD 580 billion was allocated to global equity strategies in the first half of 2021.

That’s more money than flowed in across the entirety of the 2008 to 2020 period. If this pace of inflows is sustained across all of H2 2021, they will exceed total inflows seen since the turn of the century.

Given this level of exuberance, it’s little wonder a safe haven asset like gold has lost favour, for now at least.

Market expectations that the recent inflation spike is transitory

The other major reason gold hasn’t responded more positively to the recent spike in headline inflation is the market’s belief (rightly or wrongly) that it will prove transitory. Investors seem convinced overall levels of annual headline CPI growth will head back towards a 2-3% range in the coming year, in line with current median CPI and 16% trimmed-mean CPI figures published by the Federal Reserve Bank of Cleveland.

Further evidence of the markets belief that the current inflation spike will prove transitory can be seen clearly in the table below, which highlights actual CPI levels at the end of July 2021, as well as market expectations for average inflation over the next 10 years, and the gap between these readings.

Annual change in CPI and 10-year breakeven inflation rate (%)

Source: St Louis Federal Reserve, 10-year breakeven inflation rate taken as at August 11

This gap is almost unprecedented. Indeed, you’d need to go all the way back to the end of August 2008 to see such a large divergence between actual CPI levels and market expectations for average inflation over the next 10 years, as the chart below (which also shows the US dollar gold price) highlights.

Annual CPI minus 10-year breakeven inflation rate (%) and USD gold price


Source: The Perth Mint, St Louis Federal Reserve, World Gold Council

Equities fared horribly in the period that followed the inflation differential seen in Q3 2008, falling by 40% in the next six months.

Gold, on the other hand, went from strength to strength, rallying by more than 100% in the three years that followed, with an ultimate peak just below USD 1,900 per troy ounce on 5 and 6 September 2011.

A lost decade for gold

It is now almost exactly 10 years since gold peaked in its last cycle, with the price still below the levels seen for that short period in Q3 2011.

It is, of course, worth noting that:

• All the pain felt by gold bulls across the past decade was concentrated in the time period from late 2011 to the end of 2015, with gold falling 45% to bottom out at approximately USD 1,050 per troy ounce. Since then, the gold price is up more than 60% in US dollar terms, even allowing for the current pullback.

• Average prices across the last 10 calendar years (which arguably give a fairer perspective for all investors, rather than intra year highs and lows), show a much more modest pullback in gold of just 30% from peak to trough. They also suggest that gold, which has so far averaged just over USD 1,800 per troy ounce in 2021, is trading 15% above the average price seen in 2011.

• The lost decade is almost exclusively a US dollar-based observation, with gold performing more strongly in a range of other currencies over the period. This can be seen in the table below, which highlights gold’s price move in major developed market and consumer nation currencies, including Australian dollars, between 5 September 2011 and 6 August 2021.

Gold prices and performance (%) in multiple currencies


Source: World Gold Council


Despite the above caveats, it can’t be denied that it has been a tough 10 years for precious metal bulls investing in US Dollars. Several factors explain this lost decade, including:

Extreme outperformance leading into 2011

In the 10 years to end August 2011, the gold price in US dollar terms rose by more than 550%, while the S&P 500 price index was essentially flat. There were of course multiple contributors to this, from gold’s extremely low price relative to equities at the turn of the century, to the subprime crisis which ultimately led to the GFC, to the US Federal Reserve’s implementation of ZIRP and QE, more than a decade ago. 


From a pure return perspective, outside of the huge gold market rally seen at the end of the 1970s, the precious metal had never had a longer, or stronger run relative to equities.

Long periods of outperformance are often followed by long periods of underperformance, no matter what asset class we are referring too.

Excess froth

By the start of the last decade, the macro case for gold was obvious.

Volatile markets, an uncertain economic outlook, a blow out in budget deficits and fears over higher inflation as the US Federal Reserve crossed the Rubicon into money printing (or not, depending on which version of Ben Bernanke you listened to) meant that gold had returned to the mainstream.

There are multiple indicators from that period that highlight this, including the fact that at one stage in 2011, GLD was not only the largest gold ETF on the market, but the largest of all ETFs in the United States. Granted, ETFs were not as popular a vehicle for investment 10 years ago as they are today, but GLD’s market leading position back in 2011 is still a sign of how popular gold was back then.

Meanwhile, a Gallup poll from August 2011 found 34% of American’s thought gold was the best long-term investment. Less than 20% of people voted for stocks and real estate at the time.

Investing in what is popular always feels safe. It doesn’t always turn out to be profitable, especially in the short to medium-term. 

Low inflation

As it turns out, the market was right to expect very low levels of inflation in the period that followed the GFC, with CPI increases averaging barely 2% per annum in the 10 years to the end of 2020, the lowest figure for any decade going back 70 years.

Whether the low inflation seen in the last 10 years ’should‘ have happened given the monetary environment we have been in is beside the point. It did, and it’s been a key factor holding gold back. 

Commodity bear market

As we highlighted in an early 2021 research report for institutional investors, the past decade has been particularly unkind for commodity markets as a whole, with the Bloomberg Commodity Index dropping more than 60% between April 2011 and April 2020.

This can be seen in the chart below, which tracks movements in this index since the early 1990s.


Source: Bloomberg

While gold has historically offered a range of portfolio benefits that a broader basket of commodities can’t replicate, a profound bear market in commodities still represents a headwind for the precious metal.

The rise of Bitcoin

While we think it’s impact on the gold market is heavily overstated by cryptocurrency advocates, especially those who (incorrectly in our view) claim Bitcoin is gold 2.0, it’s fair to say the rise of this nascent asset class has taken some of the attention, and quite likely some of the investment dollars, that might otherwise have found their way into the precious metal over the last 10 years.

What 50 years of market activity has taught us about gold

Despite the lost decade, gold can still play a valuable role in investment portfolios, with studies of market data over the entirety of the last 50-years demonstrating that the precious metal can provide:

Long-term growth

As highlighted earlier, gold has delivered capital gains of approximately 8% per annum over 50 years. It doesn’t deliver an income stream (not ideal, but a ‘known known’ as Donald Rumsfeld might have said), but there is no rule that says an investment can’t deliver all of its gains on the capital side of the ledger.

Despite the lack of yield, the total return delivered by gold has exceeded cash held in the bank, most segments of the fixed income universe, and the capital (if not total) return on equities.

An effective equity market hedge

As we have highlighted in previous research reports, gold can provide protection and growth for a portfolio, as it’s negatively correlated to equities when they fall, yet is positively correlated when they rise.

For Australian investors this is perhaps best visualised through the following table, which looks at 50 years of Australian equity market and gold price (unhedged in Australian dollars) return data. The table highlights the average return for both equities and gold in the calendar years equities rise, and in the years they fall.

Average annual equity market and gold price returns (%) in rising and falling equity market environments


Source: The Perth Mint, Reuters

If history is any guide, and assuming low cash rates remain a feature of the investment landscape for some time to come, then gold is likely to be a much more effective defensive asset compared to cash going forward. 

An asset that can prosper in high inflation or low inflation environments

While gold tends to do best in sustained periods of higher inflation, with average returns above 15% in years CPI rises by 3% of more, it has also historically delivered positive returns in low inflation environments. In the years CPI has risen by 3% or less, gold has still on average delivered gains of just over 5%.


Taken as a whole, 50 years of data tells us gold is a hedge against monetary turbulence irrespective of whether that turbulence expresses itself as sustained periods of higher inflation, or via a series of deflationary shocks.

Efficiency, given the gold market is large, liquid and low cost

Gold turns over more than USD 150 billion per day, making it more liquid than most equity markets (let alone individual stocks) and most bond markets. At more than USD 11 trillion in market value, the gold market is also larger than most equity and fixed income markets.

It’s for this reason gold can be one of the lower cost investments an investor can allocate too, evidenced through the fact that trading spreads and management fees for gold ETFs, including Perth Mint Gold (ASX:PMGOLD), are amongst the lowest of any ETF an investor can buy.

Ultimate stability, given its continued status as a reserve asset

Gold also clearly remains an important reserve asset for central banks, who collectively hold more than 35,000 tonnes of the precious metal, worth almost USD 2 trillion at today’s prices.

Its importance in this regard is only growing, particularly for emerging markets, with central banks as a whole having increased their holdings by approximately 20% (5,000 tonnes) since the GFC hit just over a decade ago.

The road ahead

While there are no guarantees, a solid case can be made that the coming decade will be far more favourable for gold and that the precious metal will remain a very useful asset to include in a portfolio.

Factors supporting this conclusion include:

Sentiment toward gold has shifted

In a complete reversal of the situation gold found itself in as it was heading towards USD 1,900 per troy ounce in 2011, gold is now largely unloved by investors, who are far more convinced that stocks and real estate are the safer long-term bet. This can be seen in the table below, which is drawn from Gallup poll data from 2011 to 2021

Which asset do Americans think is the best long-term investment (%)?

Source: Gallup polls


Indeed, on a relative basis, gold is as unloved as it has ever been relative to real estate, while it is still far less popular than equities are today.

Data like this doesn’t prove anything per se, but these are the kind of signals one would expect to see when a market is close to bottoming. By way of reference, gold today is essentially as popular as equities were back in 2011. The S&P 500 has rallied by more than 230% since then.

Extreme equity market outperformance

The relative performance of equities vs. gold is the complete opposite today as compared to Q3 2011, when gold’s lost decade began. Back then, gold had outperformed the S&P 500 by more than 500% on a 10-year basis.

By the end of last month, gold was underperforming by more than 225%, with the rolling 10-year performance differential between gold and equities seen in the chart below.

Rolling 10-year performance – S&P 500 (price index) minus US dollar gold


Source: The Perth Mint, World Gold Council

Good things happen to cheap assets, as the saying goes. Relative to equities, gold is about as cheap as it’s ever been on a rolling 10-year basis.

Traditional asset returns are likely to be constrained in the decade ahead

The next decade is unlikely to be anywhere near as rewarding for investors with portfolios concentrated in equities and fixed income assets.

This is something that institutional asset managers have openly acknowledged. The table below, which highlights a range of US financial market and economic indicators, illustrates how different the situation is today relative to Q3 2011, when gold’s lost decade began.

Note that some data is taken from the date closest to Q3 in either 2011 or 2021 - for example federal debt to GDP ratios are from end 2011 and the forecast for end 2021 from the Office of Management and Budget.

US financial market and economic indicators

Source: US Office of Management and Budget, US Federal Reserve, Yardeni Research, Robert Shiller Online Data, Standard and Poor’s, United States Treasury.

The table makes it clear that investors are now paying almost double the amount of money to purchase a dollar of company earnings and almost triple the amount of money to purchase a dollar of company sales relative to a decade ago. Meanwhile, zero credit risk US Treasury bonds are now guaranteed wealth destroyers if held to maturity.

At a macro level, debt to GDP ratios are now far higher, as indeed they are all over the developed world, while the Federal Reserve balance sheet, both in dollar terms and as a share of the economy, has doubled relative to a decade ago.

The response to the pandemic has undoubtedly exacerbated these trends, but it is not their only cause, with the global economy already slowing down well before the vast majority of us had ever heard of COVID-19.

Given these factors, we wouldn’t be surprised to see gold outperform, or at the very least match the return delivered by equities in the decade to come, despite the fact sentiment toward the precious metal remains lukewarm at best today.

Disclaimer:
Any opinions expressed in this article are subject to change without notice. The information in this article and the links provided are for general information only and do not contain all information that may be material to you making an investment decision. The Perth Mint is not a financial adviser and nothing in this article constitutes financial, investment, legal, tax or other advice. Before making an investment decision you should consider whether it is suitable for you in light of your investment profile, objectives, financial circumstances and the merits and risks involved. 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 have not been independently verified by The Perth Mint and we do not guarantee their accuracy or completeness. The Perth Mint does not accept any liability, including without limitation any liability due to any fault, negligence, default or lack of care on the part of The Perth Mint, for any loss arising from the use of, reliance on, or otherwise in connection with the information contained in this article.



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Gold rallies as Delta fears grow



Gold prices rose by almost 4% during July as fears over the spread of the COVID-19 Delta variant helped push bond yields lower. Despite the rally, the precious metal remains range bound around USD 1,800 per troy ounce, with the market awaiting a decisive catalyst to determine whether we see more short-term weakness, or a move back to all-time highs later in the year.

Summary of market moves:

Gold prices rallied by 3.6% in US dollar terms during July, with the precious metal ending the month trading back above USD 1,820 per troy ounce.
The strength in gold did not translate to silver, which fell by 1.1% across the month.
Continued weakness in the Australian dollar, which fell 1.8% to USD 0.738, helped push the local gold price up by 5.5% for the month.
Stock markets continued to climb higher, with the S&P 500 up another 2.3% during July. It has now almost doubled since the lows seen in March 2020.
Yields fell sharply during July, with US 10-year Treasuries ending the month yielding just 1.24% (-1.17% real), down from 1.45% (-0.87%. real) at the end of June.
Cryptocurrency markets rallied with the price of Bitcoin rising by 14% in July to end the month back above USD 40,000 per coin.

Full report - July 2021

Gold prices rallied by almost 4% in US dollar terms during July, with the precious metal finishing the month trading at USD 1,825 per troy ounce.

A decline in both nominal and real yields, combined with rising fears about the spread of the Delta variant of COVID-19, supported gold during the month, though it did not translate to higher prices across the entire precious metal complex, with silver (-1.1%), platinum (-1.4%) and palladium (-1.8%) all falling in US dollar terms.

Australian dollar investors fared better than their US counterparts, with gold ending the month trading back above AUD 2,450 per troy ounce, up more than 5% during July and now positive on a calendar year to date basis.

Despite the bounce, gold remains range bound, with the market looking for a catalyst to move it decisively in either direction. On the positive side, higher rates of inflation, falling bond yields, central bank buying, and pandemic related threats are expected to provide support.

On the negative side, the market’s apparent belief that inflationary pressures are likely to prove transitory, and continued strength in equity markets, are holding back safe haven demand.

We explore some of these factors in more detail below.

Why isn’t gold higher?

Despite the bounce in July, some commentators argue that gold is underperforming at present, with higher than expected inflation and declining real yields failing to propel the precious metal back toward USD 2,000 per troy ounce as yet.

The below table, which shows the gold price and real yields on the day gold hit all-time highs in August 2020, at its lowest point in 2021 and again at the end of July, illustrates their point.

US dollar gold price and real yields on US Treasuries


Source: LBMA, United States Treasury

The table highlights the fact that real yields rose (though remained negative out to 20-year bonds) between August last year and March 2021, which in part explained the almost 20% decline in the gold price over that time period.

Since the end of March though, real yields for bonds of all maturities have again fallen and are now lower for 5- and 10-year bonds compared to where they were back in late August.

Despite this, gold currently remains more than USD 200 per troy ounce below the August 2020 high.

Two primary factors are responsible for this. The first centres around the belief widely held in the market today that currently high rates of consumer price inflation will prove transitory. (US CPI was +4.2% in April, +5.0% in May, and +5.4% in June.)

This theory is supported by belief that much of the inflationary pressure evident in the market is driven by a combination of:

base effects - for example energy prices, which had cratered in the first half of 2020, up 25% in the year to end June.
supply chain disruption - with COVID-19 related shutdowns creating bottlenecks in the global economy that have led to short-term price spikes that will ease over time.

As evidence of the supposedly transitory nature of the current surge in inflation, commentators are pointing to the fact that median CPI has increased by just 2.2% in the last year.

This means that the difference between overall CPI and median CPI is now over 3%, the largest gap in the last 20 years, with the annual changes in both inflation measurements seen in the chart below. 

Annual change (%) in overall CPI and median CPI


Source: Federal Reserve Bank of Cleveland

Irrespective of whether one personally agrees with the above argument, there is little doubt that it is the predominant narrative in the market today.

As the market doesn’t perceive inflation to be a sustained threat, it helps explain why gold, which is typically highly sought after as an inflation hedge, is yet to move higher.

The second, and arguably more important factor holding gold back right now is momentum, particularly the relative momentum between gold and equities.

While some investors may scratch their heads at how, or why, equity markets continue to push higher, the fact is that they are. Indeed, so powerful is the momentum in equity markets that the S&P 500 is only a couple of percentage points away from doubling since the lows seen in March last year.

As this article highlights, should the market reach that milestone in the coming weeks, it will be by some margin the fastest doubling of stock market lows on record, easily beating the time it took for markets to recover from the crash caused by the Global Financial Crisis just over a decade ago.

On a rolling 12-month basis, the S&P 500 was up 34% in the year to end July, with the past few months seeing some of the best year on year performance for equities on record, something we highlighted in chart form in last month’s report.

We’ve included that chart again below, though this time we have expanded it to include a line (gold coloured on the chart) which shows the price performance of the S&P 500 minus price movements in gold. When the number is above zero it means the S&P 500 is outperforming gold, and when it is below zero it is underperforming gold, on a rolling 12-month basis.

The chart highlights that relative to gold’s rolling 12-month performance, the S&P 500 is outperforming at an almost record pace.

Indeed, the only other times equities have outperformed so significantly was in late 2013 (after gold had crashed in US dollar terms), the late 90s (towards the end of gold’s two decade bear market and a very strong period for stocks), the start of the 1980s (end of the last great bull market in gold), and the mid-1970s (mid-cycle correction for gold).

Rolling annual performance for the S&P 500 and S&P 500 minus gold performance

Source:  The Perth Mint, LBMA, Bloomberg

Given the overwhelming momentum that is evident in risk assets, it should be no surprise gold has not yet reclaimed the USD 2,000 per troy ounce level, even if real yields across part of the maturity spectrum are in line or even lower than they were back in August last year.

It simply doesn’t have momentum on its side right now.  

This is a point that Charlie Morris, the Editor of the Fleet Street Letter and a highly respected precious metal (and crypto) commentator, covered in a 28 July article titled "Why is gold so cheap?".

Charlie’s article included the below chart, which highlights the US dollar gold price and total holdings in gold ETFs plus the net long position amongst speculative gold traders.


Source: Charlie Morris, Bloomberg

The correlation between the two is very clear, with the chart telling us the appetite for gold amongst developed market investors has waned since August last year, and that this is a key factor holding prices back at present.

Despite this soft patch, there are analysts and investment managers who remain positive on gold’s price trajectory moving forward. These include fund manager Diego Parrilla, who oversees USD 250 million in assets, who recently stated that he thinks “the drivers for gold strength not only remain but actually have been strengthened.”

According to this article, Parrilla holds the opinion that gold may well trade somewhere between USD 3,000 and USD 5,000 per troy ounce in the next three to five years. 

Gold demand trends

The World Gold Council (WGC) just released its latest quarterly Gold Demand Trends report, which looked at developments in precious metal markets up until the end of June. Key findings included:

• A 56% year on year increase in bar and coin investment, with strong demand continuing in Western markets.
• A 60% year on year increase in jewellery demand, though this is from the extremely depressed levels seen in Q2 2020, with demand from this segment still 17% lower than the average demand seen between 2015 and 2019 (i.e. pre COVID).
• 200 tonnes of net purchases by central banks, with Thailand, Hungary and Brazil the main buyers. Over the first six months of the year, net purchases have totalled 333 tonnes, the third highest H1 figure in the last decade.
• Modest inflows into gold ETFs, with holdings increasing by just over 40 tonnes across the quarter. While this is positive, it represents a 90% decline relative to the more than 400 tonnes of inflows seen during Q2 2020, with this decline a perfect illustration of the more subdued environment gold finds itself in right now.

Interestingly, the WGC report pointed out that the US dollar gold price averaged 1,816.50 per troy ounce in Q2 2021, which was 6% higher than the average price seen a year ago.

This statistic provides important perspective. While sentiment towards gold is lukewarm at best right now, and the price is currently trading close to 10% below the all-time high seen last August, the fact that the average gold price in Q2 2021 is 6% higher than a year ago illustrates that we are still in a positive environment for the precious metal.

In due course, this is likely to encourage more investors to increase their allocations to gold, especially given the multiple challenges they face today, including:

• Inflationary pressures which continue to build.
• Yields on defensive assets that remain low or negative across the maturity spectrum.
• Risk assets trading at or near all-time highs.

Sentiment will inevitably shift, even if the timing remains unclear. When it does, those with strategic allocations to gold and other precious metals are likely to be rewarded.

Disclaimer:

Any opinions expressed in this article are subject to change without notice.The information in this article and the links provided are for general information only and do not contain all information that may be material to you making an investment decision.The Perth Mint is not a financial adviser and nothing in this article constitutes financial, investment, legal, tax or other advice. Before making an investment decision, you should consider whether it is suitable for you in light of your investment profile, objectives, financial circumstances and the merits and risks involved. 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 have not been independently verified by The Perth Mint and we do not guarantee their accuracy or completeness. Perth Mint does not accept any liability, including withoutlimitation any liability due to any fault, negligence, default or lack of care on the part of The Perth Mint, for any loss arising from the use of, reliance on, or otherwise in connection with the information contained in this article.



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Dollar rally sparks sharp gold sell off

Perth Mint gold and money stacks

Precious metals fell sharply in June 2021, with gold, which fell by more than 7%, recording one of its largest monthly declines of the last decade. The key driver of the sell-off was as a more hawkish US Federal Reserve, which brought forward its projections for when monetary policy in the United States may tighten, sparking a rally in the value of the US dollar. The pullback in precious metals, while frustrating for bulls, has seen sentiment and technical indicators hit levels that are often seen when the market is close to bottoming.

Summary of market moves:

    • Gold and silver prices suffered major falls in June, with the two precious metals down by 7% in US dollar terms. 

    • Prices for the two precious metals in Australian dollar terms fell by closer to 4.5%, owing to a 2.5% decline in the AUDUSD FX rate, which ended June at 0.752.

    • A more hawkish tone by the US Federal Reserve, which sparked a rally in the US dollar was the primary driver of the pullback in precious metal prices, with real yields largely unchanged for the month.

    • Sentiment toward precious metals was negatively impacted, while technical readings also suggest the market is oversold.

Full report - June 2021

Gold and silver prices experienced sharp falls during June, with the 7% decline in the gold price representing the sixth largest monthly fall since the start of 2010, with the 10 largest monthly corrections over this time period highlighted in the table below.

table 1Source: The Perth Mint, World Gold Council, LBMA

Interestingly, two of the other top 10 monthly price declines (February 2021 and November 2020) were also part of the current corrective cycle that dates back to the middle of August last year, when gold was trading at all-time highs above USD 2,050 per troy ounce.

This helps highlight how difficult the last nine months have been for precious metal bulls, and how it has come to pass that gold has actually fallen over the 12 months to end June. While that might seem hard to fathom given the events of the last year, which would have been expected to drive the price of safe haven assets higher, it’s worth highlighting the fact that gold is still up 16% since the start of 2020, when the world first started appreciating the COVID-19 threat.

Gold also remains almost 50% higher compared to September 2018, which was around the time developed market central banks began easing monetary policy in an effort to stimulate flagging levels of economic growth.

While the longer term return figures for gold remain impressive, there can be no doubt that the recent weakness has shaken the faith of certain segments of the precious metals market. June saw a notable decline in bullish positioning in the futures market, particularly in the latter part of the month, while ETFs also saw outflows, which we explore below in more detail.

The recent weakness also saw sentiment toward precious metals take a significant hit, while technical indicators have now fallen to levels that often coincide with market bottoms.

What has driven the pullback in gold?

The recent sell off in precious metals was mostly attributed to a more hawkish than expected Federal Reserve, whose June policy meeting now has the market expecting an earlier return to interest rate hikes, which could now occur in 2023.

This is not to say the Fed is in a rush to walk back the extraordinary stimulus it is providing markets, and indeed in its June policy meeting it reaffirmed the commitment to purchase USD 120 billion per month of Treasury and mortgage backed securities and maintain the Federal Funds rate between 0 - 0.25%, among a range of other policy tools currently being deployed.

Nevertheless, the market’s interpretation of a change in tone from the Fed helped push the US dollar higher (the US Dollar index is now up over 3% since the late May lows), and in the short-term also caused real yields to jump, with both of these factors helping drive the sell-off in gold.

Short-term price moves aside, we think there are at least five factors that have driven the gold price correction since August of last year, with the precious metal now down 15% from the all-time highs seen back then.

Those factors include a stabilisation in real yields, strong stock market performance, rising economic optimism as the threat of COVID-19 recedes (as hard as that may be to believe in Australia right now), the attention that Bitcoin and cryptocurrencies have generated, and last but by no means least, the level of froth that existed in precious metal markets nine months ago.

Stabilisation in real yields

Over the long run, gold prices are highly correlated to real yields, which is logical given the real yield available on credit (but not inflation) risk free US Treasury bonds are one of, if not best, indicators of the opportunity cost of owning an income free asset like gold.

The chart below, which highlights the US dollar gold price and the real yield on a 10-year US Treasury bond from 2003 to the end of 2020 illustrates the relationship between the two.

US dollar price of gold and real yield on a 10-year US Treasury

Graph 1

Source: The Perth Mint, Reuters, US Treasury, St Louis Federal Reserve

Since gold peaked in August 2020, real yields for longer dated US Treasuries, which are those with 10, 20 or 30-year maturities, have increased -, which is to say they are now less negative than they were nine months ago. This can be seen in the table below.

Source: United States Treasury 

Strong stock market performance

Since the COVID-19 induced market lows seen in March 2020, stock markets around the world have staged an almost unprecedented rally. In Australia for example, the ASX 200 is up more than 50%, whilst in America, the S&P 500 has almost doubled.

On a rolling one-year basis, the S&P 500 was up almost 40% in the year to end June, making the last 12 months one of the greatest market rallies of the last 50 years. This can be seen in the below chart, which highlights year on year movements in the S&P 500.

Rolling annual returns for the S&P 500

Source: The Perth Mint, Yahoo Finance

The rise in equity prices has also seen a meaningful shift in portfolio allocations, with investors upping their exposure to share markets. Indeed, data released from Bank of America Merrill Lynch in late June suggests equity allocations within client portfolios are now at all-time highs.

Furthermore, on an annualized basis, inflows into equities in the first six months of 2021 have been so significant that if they continue at their current pace for the rest of the year they will be substantially larger (circa 50%) than cumulative inflows for the past 20 years combined. 

As a final sign of the exuberance in risk assets today, CFTC data suggests small speculators have never had more money invested in long, equity market futures contracts, which require the market to keep rising in order for them to make money.

While gold is typically positively correlated to rising stock markets, there is no doubt it really comes into its own during periods of market distress (for example in Q1 last year when it outperformed the stock market by almost 25%).

Given we are in the midst of such a strong stock market rally, and seeing so much money pour into equities, it’s no surprise the appetite for a safe haven asset like gold has waned over the past few months, putting downward pressure on prices.

Rising economic optimism

Despite the ongoing threat posed by COVID-19, optimism regarding the economic outlook has improved markedly in the past few months, driven by vaccine rollouts across most of the developed world, and fiscal stimulus measures which have supported cashflows for households and businesses.

Growth forecasts continue to be revised up, while consumer confidence in the United States is now soaring, with the latest Conference Board numbers suggesting confidence levels are back to where they were roughly 18 months ago before the pandemic hit.

Bitcoin

Despite the 50% correction that we have seen in Bitcoin (BTC) prices in the past few months, it has been a very strong year for cryptocurrencies.

On the day gold peaked back in early August 2020, BTC was trading below USD 12,000 per coin. It then went on to rise almost five times over, trading at almost USD 65,000 per coin in mid-April this year.

Even after the correction it has had since that April high, the BTC price is still more than triple where it was when gold peaked, with the chart below (which comes from our late February research report: Gold, Bitcoin and the Elon effect) highlighting the price movements of the two assets since the start of last year.

While gold and BTC have very different risk profiles, the rise in the price of BTC and the attention that it has generated given the launch of BTC ETFs, the news that Tesla added BTC to its balance sheet, and the perpetual marketing of BTC as “digital gold”, have had some negative impact on gold in the past six to nine months.

Froth

The final reason gold has corrected since August 2020 is simple. It was overbought and way too popular, with the move above USD 2,000 per troy ounce sparking a wave of bullish headlines and price forecasts, which often occur just before an asset is set to undergo a correction.

As we pointed out last year, gold was also trading at more than 20% above its 200-day moving average (200DMA), a level that often coincided with interim market tops, as the following chart highlights.

USD gold price per troy ounce and 200DMA

Source: The Perth Mint, World Gold Council

The good news is that as at the end of June 2021, gold was trading 4% below its 200DMA. That doesn’t mean the market has bottomed, but all the froth that was evident in the market in August is well and truly gone.

That’s a positive sign.

Physical markets, ETF flows and managed money positioning

Given the multiple factors that have driven the gold price correction over the last few months, it should come as no surprise that the demand picture for the precious metal has been a mixed bag in 2021. On the physical side of the market, volumes out of India, which had been robust initially, continue to be impacted by COVID-19.

Despite this, Swiss exports to Asia were climbing up until the end of April, helped along by the price pullback in Q1, though they then dropped by more than 50% in May as the USD gold price rallied back toward USD 1,900 per troy ounce.

The sharp gold price sell-off in late June reignited demand from China in particular, something The Perth Mint has seen first-hand with buyers returning to the market and adding to their holdings.

Perth Mint minted product sales also tell an interesting story, with Q1 seeing some of the highest levels of demand for gold and silver on record. Interestingly, in Q2, gold sales fell, with June being the slowest month since January, while silver continued to see impressive demand, which the following table attests too.

Source: The Perth Mint

In the gold ETF space, we’ve seen the better part of 145 tonnes of gold (4% of total global holdings) divested from these products in the first half of the year, though June only saw modest outflows.

Most of the outflows for the year have come from North American investors, with smaller outflows seen in Europe. Interestingly, investors in Asia are still continuing to accumulate gold through ETFs, including in Australia, where Perth Mint Gold (ASX:PMGOLD) saw inflows of almost 3,000 ounces (just over 1% of fund holdings) in June.

The futures market also tells an interesting story, which can be seen in the chart below. It shows net positioning amongst managed money speculators as well as the US dollar gold price since late 2009. 

USD gold price per troy ounce and net managed money futures positioning

Source: CFTC, The Perth Mint

The chart highlights that increases in net positioning typically occur, and indeed contribute to rising gold prices, while the reverse is also true. Over the course of the first six months of this year, the net position almost halved.

This was predominantly driven by a more than 30% decline in long exposure, much of which occurred in the last two weeks of June, after the US Federal Reserve meeting.

While this has undoubtedly contributed to the recent price weakness in gold, long positioning has now fallen to levels seen near the bottom of corrective cycles.

That’s no guarantee that the next move in prices will be to the upside, though it should provide some encouragement to long-term investors happy to add to positions during pullbacks like the one we are experiencing now.


Disclaimer:

Any opinions expressed in this article are subject to change without notice.The information in this article and the links provided are for general information only and do not contain all information that may be material to you making an investment decision.The Perth Mint is not a financial adviser and nothing in this article constitutes financial, investment, legal, tax or other advice. Before making an investment decision you should consider whether it is suitable for you in light of your investment profile, objectives, financial circumstances and the merits and risks involved. 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 have not been independently verified by The Perth Mint and we do not guarantee their accuracy or completeness.The Perth Mint does not accept any liability, including without limitation any liability due to any fault, negligence, default or lack of care on the part of The Perth Mint, for any loss arising from the use of, reliance on, or otherwise in connection with the information contained in this article.



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