Gold is breaking out after a very long stretch of inactivity:
- Friday’s close at $1,400/oz puts the yellow metal at +8.9% on the year.
- The last time gold was at similar levels was in mid 2013.
- Over the last 5 years it has meandered between $1,075-ish (Q4 2015) and just over $1,350 (mid 2016, September 2017, and early 2018).
So what’s going on? Three points to consider:
#1. The current global rate reset helps…
- As noted in the Markets section there is some $13 trillion of negative yielding debt around the world, a new record that coincides with gold’s recent Lazarus-like move.
- Since gold pays no dividend and costs money to store, its theoretical attractiveness as a store of value increases when interest rates drop through zero.
- The expense ratios for the GLD (SPDR Gold Shares ETF) and IAU (iShares Gold Trust) ETFs are reasonable proxies for storage expense, at 40/25 basis points respectively.
- That puts the average gold holding cost at 33 bp, not far off German 10-year Bunds (-28 bp) and actually cheaper than all German sovereign debt with maturities less than 10 years (-37 to -77 bp).
Takeaway: It is actually cheaper to store capital in gold than in some liquid financial assets just now. Yes, there is capital risk. But remember that gold has been relatively stable over recent memory, so buyers may well feel that this is a risk worth taking.
#2: … And so does market sentiment that the Federal Reserve will be cutting interest rates, causing a further decline in the value of the dollar:
- Gold, like oil, is largely priced in dollars across all major global end markets. A strong dollar hurts its affordability, whether you are talking Indian wedding gifts (an important source of demand) or buyers’ interest from Greater China.
- Measured by the DXY Index the dollar dropped by 1.5% last week, its largest 5-day decline of the year. Still, it would take a further drop of 2.3% just to take it to 1-year low levels.
Takeaway: currency and gold markets were late to the party in terms of expecting a more dovish Fed but are now making up for lost time. Fed Funds Futures markets were, as we have repeatedly highlighted in these notes, first in the door and now other capital markets (stocks included) are catching up.
#3: As far as near-term sources of gold demand, the Q1 World Gold Council Demand Trends report shows one interesting buyer:
- Global gold demand grew by 7% in Q1 2019 against an easy comp. Q1 2018 demand was at a 3-year low.
- Central bank buying was the largest source of “surprise” demand, up 146 tons and the largest add for any Q1 back to 2013 when it comes to this sort of buyer.
- ETF demand was also good, up 49% year-over-year, but industrial demand (mostly from the Tech industry) hit a 2-year low. There is an average of 0.034 grams of gold in every cell phone, by the way…
- Gold supply, both newly mined and recycled, was flat in Q1.
Takeaway: global central banks – think Russia and Turkey – have been the marginal buyer for gold not just in Q1 but last year as well. That they bought more in Q1 than usual for this period indicates they are not likely done with their purchases. The “barbarous relic” may not be a part of how western central banks consider policy, but it still clearly plays a role elsewhere.
Summing up: gold is getting a lot of buzz just now and it’s easy enough to see why. Buoyed by lower global rates and continued central bank buying, the runway looks clear. From an investment standpoint, we’re in the camp that says a 3-5% weighting in gold is prudent. But unlike the last 5 years, such a position should now actually earn its keep.
World Gold Council report: https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q1-2019