Much before Covid-19’s impact reverberated across economies and led to a crash in global stock markets, gold prices had started their upward glide since May 2019 to culminate into a nearly 40 per cent jump in less than a year, from $1250 (an ounce) to around $1977.67 (an ounce) plus now (as on 31st July, 2020). The present gold prices in India are even higher, as they jumped from around Rs 32,000 per 10 grams to nearly Rs 55,495 per 10 gram (as on 31st July, 2020) during the same period, a nearly 73.42 per cent return.
Gold rallied to a record high and gold futures touched $2,000 an ounce as financial markets digested the havoc caused by the coronavirus pandemic. And that breathed new life into the old question of why investors still bother with what’s likely the most primitive form of money in their portfolios. Bullion is best known as a time-honored haven from inflation, but there’s more to its appeal, and plenty of conflicting forces at work that can excite investors.
Rate of Return on Gold Investment-
Historically, gold has generated long-term positive returns in both good times and bad. Looking back almost half a century, the price of gold has increased by an average 14.1 per cent per annum since 1973 after Bretton Woods collapsed and the gold standard system of pegging the currency to gold ended, WGC says. It has surged nearly 40 per cent in the last one year while the Sensex showed a loss of 0.41 per cent at 37,871.52 (Wednesday closing) in the same period.
Reasons for a Surge in Gold Prices-
Last year, there have been intermittent reports based on economic indicators suggesting that the US economy could enter into recession after a record 11 years of economic surge since the global financial crisis of 2008. This expectation of recession sowed the seeds of the gold rally, and the Covid-19 impact, which has virtually led to a shutdown of major economies across the world, added momentum to the rising gold prices as a major global recession now looks certain.
Though equity markets around the world rebounded sharply from their March lows, the high level of uncertainty surrounding the Covid-19 pandemic and the ultra-low interest rate environment supported strong flight-to-quality flows. Like money market and high-quality bond funds, gold benefited from investors’ need to reduce risk, with the recognition of it as a hedge further underscored by the record inflows seen in gold-backed ETFs. Gold prices in India are dictated by international prices.
International gold prices have been on the rise in the last a few months and picked up pace amid sharp losses in the dollar, additional stimulus measures and robust investor inflows. Rising virus cases and US-China tensions have also underpinned the gold price.
With the dollar substantially weaker, a lot of funds are moving into gold right now. And as long as the (virus situation) gets worse, the market is discounting more stimulus for a longer period of time and in bigger quantities, and all of that is bullish for gold.
The dollar fell to a near two-year low versus major currencies as a standoff between Washington and Beijing showed no signs of abating with both sides ordering the closure of consulates in Chengdu and Houston.
The COVID-19 outbreak also continued to worsen, with more than 16.13 million people cases globally and 644,836 deaths (as of 27th July, 2020), driving expectations of more stimulus globally to ease the economic blow.
It tends to benefit from widespread stimulus since it is considered a hedge against inflation and currency debasement.
Why is Gold Considered a Safe Haven?
Gold had a remarkable performance in the first half of 2020, increasing by around 25 per cent from its low in March and significantly outperforming all other major asset classes. Gold futures prices soared to a nine-year high of $ 1,856.60 per troy ounce in London on Wednesday, inching closer to their record high of $1,920 an ounce hit in September of 2011.
It is traditionally used as a hedge against inflation and considered as a safe haven for investors during periods of uncertainties. Whenever stock markets, real estate and bonds fall across the world, investors turn to gold to park their funds. The fall in the value of other asset classes and global uncertainties in the wake of Covid-19 helped gold climb to a record high. A key factor behind this robust performance is that the supply growth of gold has changed little over time – increasing by approximately 1.6 per cent per year over the past 20 years. In contrast, fiat money can be printed in unlimited quantities to support monetary policy, as exemplified by the Quantitative Easing (QE) measures in the aftermath of the global financial crisis. Gold, established as an investment, a reserve asset and an adornment, is highly liquid, no one’s liability, carries no credit risk and is scarce, historically preserving its value over time.
Gold as Inflation Hedge-
An inflation hedge is an investment that is considered to protect the decreased purchasing power of a currency that results from the loss of its value due to rising prices either macro-economically or due to inflation. It typically involves investing in an asset that is expected to maintain or increase its value over a specified period of time. Alternatively, the hedge could involve taking a higher position in assets, which may decrease in value less rapidly than the value of the currency.
The hedge against inflation is the traditional motive behind the investment in gold, but its role as an inflation hedge is perhaps the most debated and ambiguous issue in the financial press and academic literature. The truth is that the yellow metal serves as an inflation hedge in the long run, but not in the short run.
Importantly, the most reliable relationship exists between gold and strong increases in inflation, while moderate increases in inflation or declining inflation do not materially impact the price of gold in either direction. As you can see in the chart below, prices were increasing in the 70s, when the inflation rate was high and accelerating, while they were decreasing in the 80s and the 90s, when the inflation rate was declining.
Given the opportunity costs, investors should expect only significant and lasting inflation to drive the price of gold up. In other words, gold may serve as an inflation hedge only when there is relatively high inflation, usually accompanied by fears about the current state of the U.S. dollar and the global monetary system during this pandemic.
Many gold analysts have now revised their price targets saying that prices could go up to Rs 65,000 per 10 grams in the next 18-24 months. Analysts are bullish as the fundamental factors like lower interest rates, negative rates in some economies, enormous amount of liquidity and expanded fiscal balance sheets of governments which are trying to push growth amidst Covid-19 are expected to dictate the price trend. With prices on the rise, investors have embraced gold in 2020 as a key portfolio hedging strategy. Regardless of the recovery type, the pandemic will likely have a lasting effect on asset allocation. The combination of high risk, low opportunity cost and positive price momentum looks set to support gold investment and offset weakness in consumption from an economic contraction.