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Gold holds glitter in low-interest environment
Lombard Odier CIO makes case for precious metal as hedging tool as impact of pandemic on global economy seen to persist
21 Jul 2020 | The Asset
Stéphane Monier
Stéphane Monier

In turbulent times, such as the one we’re in at the moment, investors tend to turn to gold as a safe haven. But as Covid-19 raged on, investors saw the importance of cash and consequently, the prices of gold and other assets fell. Then as central banks sought to print more cash to stimulate the economy, prices rallied again.

Historically, the price of the precious metal has an inverse correlation with the value of the US dollar. But Swiss private bank Lombard Odier notes that gold has risen across all major currencies in recent months, climbing 15% year to date. It traded at US$1,801 per ounce on July 17, near its historic closing high of US$1,875.25/oz on September 11  2011.

This gives rise to the question: should investors hold gold in their portfolios at current prices?

Stéphane Monier, group managing director and chief investment officer at Lombard Odier, cites key factors supporting the price of gold, namely low-to-negative government bond yields plus a weakening US dollar, and most importantly, massive central bank accommodation. “This relationship between gold and real yields has held for the last decade and recent central bank interventions have reinforced the case for holding gold as a portfolio diversification tool,” Monier observes.

He also notes that investors may have to re-assess their exposure to sovereign debts in light of the impact of the pandemic on the ability of governments to pay their debt. “This further increases the attractiveness of gold, which even if it produces no income and is costly to store, carries no credit risk.”  

Monier believes that the current accommodative, low-yield environment may persist for a long time. He cites studies by the Bank of England and the International Monetary Fund on the impact of pandemics on economies, showing that such events “tend to depress real interest rates not for years but for decades”.

He advises investors not to worry too much about the impact of mine closures, as a result of the health crisis, on gold production. While commodity prices are affected by supply and demand, and according to the World Gold Council, the supply from gold mines fell 3% in the first quarter of this year, “the equivalent of about 60 years of supplies are already above ground, and there is a large market for recycled gold”, he notes.

Amid the global economic slowdown, demand for jewellery has declined sharply, particularly in Greater China and India, which together account for more than half of the world’s consumption of physical gold.

But while consumer demand fell amid the pandemic, investors stepped up their gold purchases. In the first half of 2020, exchange-traded funds bought a record 734 tonnes of gold worth US$39.5 billion. That’s up 600% from the same period a year ago and more than any full-year period in history, according to World Gold Council data.

Central banks, meanwhile, have turned from net sellers into major buyers of gold, accounting for around 45% of mined supply in the six months through June. Still, central banks have slowed their purchases this year from record levels of 2018 and 2019.

Says Monier: “The outlook for gold depends on this continued shift in balance from physical consumption to financial demand from investors. And investor demand depends largely on the shape of the global economic recovery, and in particular, the evolution of real yields. If, as we fully expect, the low-to-negative yield environment persists in line with sluggish post-pandemic global growth, this financial demand will likely offset the weak consumer demand for gold.”

The private bank expects gold prices to be underpinned by an improving outlook for the global economy. It sees the precious metal trading around US$1,600/oz a year from now.

However, the situation may change if the economic recovery is stronger than expected as this might convince central banks that it is safe for them to taper or suspend stimulus spending on assets. “That implies that the Federal Reserve would then be prepared to increase interest rates, although in an election year, and the current circumstances, that remains hard to imagine,” Monier concludes.

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