In the last few weeks, we have seen the price of gold rising from the ashes and tower towards record levels. It recently topped the $2000 mark; the highest it has ever been in history. To the uninitiated trader, questions as to why the price of gold has been on the rise will arise. It all has to do with the coronavirus pandemic and the different dynamics it has introduced. So what is the association between the coronavirus pandemic and the surge in the price of gold?
The last time we saw gold prices rising to very high levels was in the period that followed the 2008 global financial crisis. Gold has a historical role as a safe-haven asset; a store of value that can be used to protect against inflation as well as adverse economic events. The global financial crisis of 2008 and the devastating economic impact that followed in 2009 and 2010 produced a perfect setup for gold prices to trend upwards. As panicked investors saw their investments disappear before their very eyes in the stock market and the risky commodity markets, gold became the next destination for safety. This flight to safety drove gold prices to a then-high of $1920 an ounce in August 2011.
However, global central banks came together to implement several stimulus measures that collectively came to be known as quantitative easing. These measures gave near-bankrupt companies a lifeline and also produced a 7-year bull run in the stock market. As the stock markets and commodity prices recovered, these investments became attractive for investors once more, and investment money began to move away from gold towards these assets. This recovery caused gold prices to drop between 2012 and 2018. Thus, gold experienced a bull-to-bear run in the last decade.
The scenario that played out in 2009 and 2010 seems to be playing out again. This time, there are different reasons, even though the effect is the same.
1) The Concept of Risk-on and Risk-off Sentiment
So what is risk-on sentiment? The risk-on market sentiment describes an atmosphere where traders are willing to take more risk by investing in assets that can produce huge returns in leveraged trades. At this time, there is potential for appreciation of capital. When risky sentiment is high, investment money flows towards the riskier assets such as stocks, crude oil, copper, palladium, platinum and the commodity dollars (the Australian Dollar, Canadian Dollar, New Zealand Dollar and Norwegian krone).
But when there is a global market upheaval, the kind that occurred in March and April 2020, the focus of investors shifts away from capital appreciation to capital preservation. At this time, investment money will tilt towards assets that preserve value. Gold is one of those assets that protect value over time and also serves to guard against inflation. When investment money pours into an asset in such substantial volumes, the value of that asset will rise as demand starts to outstrip supply. This is the classical picture that gold has displayed in the first seven months of this year.
Gold Price Action: 2011 to 2020
Roughly a year ago, gold was trading at around $1170 an ounce. By April, when the effects of the coronavirus pandemic had devastated the global stock markets, gold was trading at $1780 an ounce. Stepping into September 2020, gold prices have cleared the $2000 mark as at the time of writing this article. The price of an ounce of gold has risen to $2,040; an all-time high. With the coronavirus pandemic nowhere near being controlled in many countries of the world, gold prices will likely continue to rise.
2) The Depreciation of the US Dollar
The most common pairing of gold in the financial markets is against the US dollar as the XAUUSD pair. In the last eight weeks, the US dollar has taken a hammering as a result of several factors. One of these factors is that the US currently carries the heaviest coronavirus case burden in the world. This has hit several industries and sectors within the US economy very hard. The situation has forced the Federal Reserve to cut interest rates to low levels and also implement a host of stimulus packages. Furthermore, the US government has voted to spend trillions of dollars to help prop up businesses and households after millions of Americans lost their jobs and companies around the country closed. The latest data surrounding the GDP shows that the US economy has shrunk 32.9% in the last quarter, which is the most significant contraction that the US economy has faced since the Great Depression. The combined effects of all these factors are that the US has lost its appeal and investment money is shifting to alternative destinations such as emerging markets, where interest rates are higher. As countries in Europe, Asia and other parts of the wall start to reopen their economies, the US dollar’s appeal as a global reserve currency stands the risk of being eroded.
When the US Dollar fundamentals, which are bearish at the moment, are combined with the fundamentals for gold which are bullish, the net effect is that gold prices will rise versus the US dollar. That is why the XAUUSD chart shows very clearly that price action is in an uptrend and this uptrend looks set to continue for some time to come.
The coronavirus has changed the world in so many ways. We are going to see gold attract demand for as long as the pandemic is around. This demand will probably drop off when the global economy recovers.