Gold came into this month licking its wounds after a truly rough November, during which everyone’s favorite shiny paperweight fell more than 3%.
That loss – one of the worst in years – was largely attributable to a 3.6% plunge on the first week of the month, when bond yields surged amid rapidly proliferating trade optimism. The early November pro-cyclical rotation was reminiscent of the first week of September, when yields snapped back from the August lows.
As we wrote a couple of weeks back, November’s poor performance masked an otherwise stellar year. Gold has risen more than 14% in 2019, its best year in nine, as the “lower for longer” mantra from central banks appeared to morph into “lower forever”. Ironically, demand from central banks has been another supporting factor for prices.
Although gold has come off the highs in keeping with higher US real rates (remember, all else equal, gold is just an inverse real rates play), Goldman thinks the outlook is still constructive, especially over the medium- to longer-term.
Even in the near-term, the bank reckons the risk of a sharp selloff is low, despite still high positioning. For one thing, there’s no guarantee that the pro-cyclical rotation will continue, but more importantly, the bank notes that “further upside in long term US rates is likely to come from rising inflation expectations rather than rising real rates, which matters more for gold”.
As you’re probably aware, realized inflation is running well out ahead of breakevens, ostensibly opening the door to a catch-up trade. Late last month, we wrote the following on this:
Central banks have plunged back down the rabbit hole and policy rates are at record lows across the globe. Any yield rise from here would likely be led by breakevens, not reals, and in any case, we’ve learned that rising real yields can be bullish for gold if the pain for risk assets from tighter policy ends up catalyzing a flight to safety.
Goldman writes that “a high inflation hurdle for a return of central bank hikes limits the nominal rate upside making it challenging for real rates to increase together with breakeven inflation”. Any dollar weakness would also be bullish for gold on the margins.
As far as the medium-term goes, Goldman says they “still see upside as late cycle concerns and heightened political uncertainty will likely support investment demand for gold as a defensive asset [while] household savings in major developed economies are growing strongly” producing a savings glut that may juice demand.
Further, it’s possible gold supplants DM bonds as the preferable safe-haven during a downturn given the distinct possibility that, by virtue of the low starting point, yields have less room to fall, thus leaving bonds as a less effective hedge.
“This is particularly relevant for Europe where rates are already close to the lower bound [and] it means that during the next recession when fear spikes, gold may decouple from rates and outperform them”, Goldman suggests, adding that “such a gold-rates divergence would not be unprecedented [as] there are multiple examples when rates and gold decoupled in the past”.
And what about the longer-term? Well, Goldman throws out some charts and delivers some interesting analysis around the analogous correlation between the S&P and the dollar and the S&P and gold, but the bottom line is pretty straightforward. Gold is a good hedge for when things go wrong. To wit:
Our strategy team also finds that gold historically has been a good hedge against periods of large drawdowns of the 60/40 portfolio. This was particularly true when a drawdown is caused by accelerating inflation as it was in the 1970s. Therefore, if one is concerned that the low macro volatility of 2010s will be followed by higher volatility in the 2020s, which would hurt equities, gold would be a good addition to the portfolio.
It’s also a good addition to the “portfolios” of central banks, who appear keen on gradual de-dollarization, especially as US foreign policy becomes increasingly volatile and the dollar and US financial system are wielded as weapons against allies and foes alike.
“CBs globally have been buying gold at a very strong pace [and] 2019 still looks to be a record year for CB gold purchases with our target of 750 tonnes combined purchases likely to be met”, Goldman says. If rates stay low and uncertainty remains high, CB purchases should remain “elevated”, the bank remarks, even as they expect purchases to slow a bit next year from 2019’s pace.
Finally, Goldman suggests that the fear of MMT could prompt a rally, even if actual implementation of the controversial theory remains largely a pipe dream.
“Modern Monetary Theory has been gaining more airtime recently”, the bank writes, in the course of noting that while they don’t “expect governments to adopt direct monetary financing [in the next recession] and expect inflation to remain firmly anchored, this doesn’t necessarily prevent an increase in debasement concerns if conversations around MMT become more widespread”.
As you can see, past experience suggests there doesn’t have to be any actual inflation to push up prices for the world’s oldest inflation hedge.