The Golden Indicator

In these economically-troubled times several developed countries especially the US have increased their import of gold.

· 3 min read
The Golden Indicator

In these economically-troubled times several developed countries especially the US have increased their import of gold. This isn’t very surprising since investors across the world have always found refuge in gold during volatile times. This universality of gold is because of its apparent immunity to deep economic downturns.

The first factor that creates immunity is due to a deep lack of influence of national fiscal and monetary policies on the value of gold. Gold exists in a finite quantity on this planet which essentially devolves its value to the most basic principle in economics- demand and supply. This is in contrast to fiat currency, which in principle is available in infinite supply, simply because more of it (with some restraints) can be printed any day. The second factor is due to a persisting psychological mark left by the Bretton Woods System, which existed before the free-floating system. Despite the dollar no longer being equivalent to gold, the intrinsic correlation between gold prices and the US dollar still exists. This has resulted in gold still being used as a hedge against the USD and even the Euro. During the Great Recession of 2008, gold ore mining grew 12.8% up 2.6% and prices went up by almost 50.6%. This has turned gold into a reliable indicator of recessions, with the value of gold being inversely proportional to the contraction. Even now gold prices have touched new highs as investors escape the uncertainty in the US and Europe markets. Switzerland’s exports of gold were up from 96.2 tonnes in March to 131.8 tonnes in April, when the pandemic started to peak in the western sphere.

Since gold as an investment class is so isolated from the International Political Economy (IPE) it acts as a hedge against systemic financial risk, which can be created due to a pandemic, a currency crisis, inflation, or deflation. There is also no counterparty risk since its value doesn’t depend on the economic standing of another entity. This is an opportunity for investors around the world to diversify into gold since it is uncorrelated to stocks and bonds. As a third asset class, gold acts to diversify the portfolio — which makes it a hedge. While gold might not move with stocks, that doesn’t mean it acts the opposite of stocks.

As the pandemic peaked in the US and Europe and then shifted to Latin America and Africa, the mining of gold ore took a severe beating in Q1, thereby hurting supply. This increases the preference for gold as an investment class. Just as in the Great Recession of 2008, gold continued to rise till 2011, the gold-positive conditions that are expected to lead to gold’s rise are not over. On average, it is expected that gold’s elevated price levels will extend through Q2 and Q3 of the current fiscal year, meaning that gold prices are likely to average at or even higher depending on how the crisis unfolds economically. Supporting factors for gold going forward are near-zero interest rates in the US, low-interest rates in India itself, equity volatility, lower yields on sovereign debt, and other commercial paper. Should a second wave arise, markets around the globe are expected to face severe contraction which will increase the flight of investments to precious metals, real estate, insurance, and equity swaps. An unlikely but coordinated G-7 central-bank and G-7 government stimulus, could reduce volatility and drive capital into gold again.

Investors who want to buy gold for their portfolio can choose physical gold, gold-backed ETFs, or gold-mining stocks. The easiest way to add gold however is to invest in gold-backed ETFs or stocks. Gold stocks are influenced by the price of gold and often will outperform gold prices when values are rising and underperform gold prices when the metal’s value falls. However, to reduce risk it is better to be in the whole gold stocks sector and distribute your investments accordingly after careful research.

Gold is expected to make a swift recovery in the medium term and touch even new record highs in the next 12 to 18 months. But rather than trying to time the market, investors who wish to take exposure in gold may buy at any level for the long-term goals. Depending on an investor’s age, 10–20% of one’s portfolio should be invested in gold.

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