Gold: In search of a New Reserve Currency!

Let us look at the recent Gold returns Vs. Sensex Returns.

Wow...! I need GolD :D

Wait, Was this performance ever like this? Let’s look at a year back (2019) and a year again (2018).

Ok,

Oops. It’s equivalent to Inflation Rate. 🙁

How does the same asset class give two different opinions?

Gold.

Gold is an alternative version of cash in a short text in the long-run potential to grow/ Decline above/below the inflation rate. Gold in the portfolio acts as a stabilizer, acts as insurance at the time of crisis like this (pandemic). 

I was expecting gold to cross above the crucial level of the $1900 mark, it’s now headed to cross the $2080 mark. But such momentum was quite surprised with a ~25% return since late March 2020. Around six months back, gold was trading within a range of $1400-$1500.

Returns?

Gold is best for hedging purposes in the portfolio, as evident by, In the past 40 years, on average, gold returns are above the inflation rate. Cool! 

This leads to the following question -

How will gold be an inflation hedge?

Inflation is a steady increase in the prices of goods and services over a given time frame. Inflation happens due to increases in money supply than economic output as a whole under normal economic circumstances. This money supply is leading to a steady rise in prices.

According to the world gold council, the growth in the supply of gold as changed little over time by ~1.6% per annum over the past 20 years. Thus it’s supplied as not changed much, unlike paper money, as it can be printed excessively. This result in inelasticity of supply, gold preserves its purchasing power, leading to hedge against inflation over long periods.

So in a longer duration (say 10-15 years) gold has provided returns above the inflation rate.

In Long term retun expectation = Inflation + 1-2%. Okay!

Let’s take a look 

Gold Price from 1970-2020

There are often through which gold goes under extended periods of subdued returns, like for example -

-From 1980-1990, It took ten years to hit its 1980 price levels once again. 

- In 1996-2003, It took eight years to hit its 1996 price levels.  

-In 2012-2019, It took seven years to hit its 2012 peak once again. 

Why are prices moving so aggressively in the last four months?

Gold companies’ challenges and opportunities posed by COVID-19:

In a shorter time frame, gold reacts to economic cycles and Indicators. Post the widespread of the pandemic, the national economic period began to shut down, and gold began to rise. It’s a milestone week for gold as it crossed $2000 mark the first time in its history. The second half of 2020 seems to be quite an achievement for the yellow metal. With strong uptrend, gold is already up ~25% since march-2020.

Challenges

-Decline in production due to the coronavirus related lockdown measures

-Supply chain interruptions Opportunities 

Opportunities

-Lower energy costs as the looming global recession push oil demand lower

-Rising demand for gold as a safe haven asset

-New projects and rise of digitalization

Why did gold find so much traction?

Since march gold is unstoppable on account of COVID fears, extensive monetary policy(real interest rates), stimulus, central bank purchasing, china, and Weaker rupee...

Drivers of Gold price

A. Exchange rate: USD-INR 

B. Gold denominated in USD

(Others drivers such  as customs duty, physical premium/discount are ignored for simplification purpose)

1. INR is in  longer Term depreciation trend

In a longer duration, 20 years, INR has depreciated by 2.9%; for 15 years, INR as depreciated by 4.3%. This 3-4% range is the inflation differential between India and the US.

Gold Return=  ~3-4% INR USD depreciation +Change in gold price (In USD)

2. What drives the gold price in USD?

Honestly, I don’t know as it is not backed by any cash flows or profits/loss. It’s complicated to ascertain the intrinsic value.

Gold plays a dual role – both as commodity and currency. 

A. Commodity- Because it derives its value from its raw material to meet a fundamental need - like for jewelry, medical, industrial, and other semiconductor-related industries. So understanding demand and supply can give a clear sense of pricing of gold as a commodity.

B. Currency- It’s a medium of exchange and as a store of value. When paper loses its faith, gold flourishes as a valuable mode of transaction.

A. Drivers of Gold Prices posing as a commodity:

a. Demand

On the demand side, demand for jewelry making(~47%), technological products such as semiconductors, in making specific medical treatments, and industrial usage. This will drive up the prices with the assumption of supply constant. Vice versa of the demand for this good going down will lead to a fall in gold prices.

*Expanding middle-class- An expanding middle class in emerging markets (such as China and India), leading to more significant consumption in jewelry and medicine. Combined with broader economic growth might support the demand for gold in the long-term perspective.

*Investment process digitalisation-Mobile apps for Gold investment, which allow individuals to buy, sell, invest, and gift gold, will develop rapidly on the first gold consuming markets.

*Technology-generated demand- Demand for high-end electronic components used in IoT and electric vehicles will support the gold’s position as a material of choice. However, gold’s role

in technology continues to be very low compared to other elements.

b. Supply

*Declining mine production-Mine supply is projected to decline, hit by rising costs and additional ESG expenses. Moreover, the industry could run out of minable gold in the next

few years. Therefore, recycling has to take a more significant role in the Gold sector.

*Technological advances in Gold mining Technological advances in the areas of AI, automation, and blockchain are beginning to penetrate the industry. Adoption of digital technologies

might make the sector more productive, efficient, and profitable.

*The gold supply chain is worldwide. Except for Antarctica, Gold is mined on every other continent, they are refined into bars and coins in various nations, and conveyed far and wide. This geographical scattering brings stability to the gold market.

However, if Gold Prices reduce significantly to below production cost (cost for taking gold out of the mines) – supply constraints may lead to higher prices.

Other Currency Drivers

Central Banks Buying Gold for their Reserves

Gold Reserves in tonnes across the globe.

Central banks increase Gold reserves to protect against both domestic and external shocks of the economy

In Q1 2020, Central Banks continued to buy gold to prevent growing global volatility. Net purchases amounted to 145 tonnes showing an -8% decrease in comparison with Q1 2019. Among top Russia added 158 tonnes, turkey 159 tonnes, and Poland 100 tonnes

Advantages of Gold as an investment in times of economic uncertainty:

a. Improve overall portfolio performance

b. Provide liquidity with no credit risk

c. Generate long-term returns

d. Act as a diversifier and mitigate losses

Keeping the current pace in mind, the ongoing geopolitical tensions around the globe and any escalation in tensions or any negative coronavirus news will boost safe-haven demand for gold further. 

Fun Facts!

The best estimates currently available suggest that around 197,576 tonnes of gold have been mined throughout history, of which approximately two-thirds has been mined since 1950. And since gold is virtually indestructible, this means that almost all of this metal is still around in one form or another. If every single ounce of this gold were placed next to each other, the resulting cube of pure gold would only measure around 21 meters on each side.

- Top Gold consumers- China 27%, India 23%

- Top Producer- China 420 tonnes -2019

- Top Gold producer company-Newmont produced 6.3 million ounces of gold in 2019

- The cutest Gold coin- 30g China Panda,2020 Gold Coin, 1,892.03 USD.

*Investment options

-Bars 

-Coins

-Certificates

-ETF

-Derivatives

The Incredible Health Benefits of Wearing Gold Jewelry

- Helps in Regulating Body Temperature

- Helps to fight Stress and Anxiety

- Skin Treatment

- Boosting Immunity

- Healing the Nervous as Well as the Endocrine System

Source: https://bit.ly/3ia9TYn

Data Source: 

https://www.gold.org/

Refer Disclaimer-

-Vinay Dwarakanath