When the Spanish invaded the envoys of Moctezuma in the 16th century, the natives questioned the conquistadors’ obsession with gold. General Hernán Cortés answered, ‘Because I and my companions suffer from a disease of the heart which can be cured only with gold’. The bloody battle that followed led to the capture of the Aztec empire and established modern day Mexico City. After failed attempts to get recognition for his many conquests and achievements, the General unceremoniously died years later. So, what is this obsession with gold?
Fast forward to modern times. The beginning of gold’s colossal rise began in 1971 when the Bretton Woods monetary system that linked the U.S. dollar to gold broke down and the current fiat system was born. No longer was currency backed by gold, it was now backed by government promises. For the next decade gold shimmered brightly, precipitated by the 1973 oil shock and continued until a blow off at the end of the decade induced by tightening monetary policy from 1979 to 82. Its next enduring rise came after the 9/11 attacks and continued during decade long American-led wars in the Middle East. The geopolitical instability propped up gold and coincided with a commodities boom during the 2000s, driven by emerging market demand and China’s rise to global supremacy. Gold rose nearly three-fold between 2008 to 11 in a post-financial crisis environment of nearly zero interest rates, unprecedented central back rescue packages and unemployment that peaked at 10% in America. Most leading economies suffered a similar plight.
Leading into 2020, gold has seen a modest rise reaching recent highs but remained largely unpopular due to the decade long bull market led by ‘Big Tech’. Then in a few fateful days, markets around the world were crushed as the pandemic swept the globe. Spooked investors adopted a ‘sell everything’ tactic to offset losses in markets, retreating to U.S. dollars. While equities generally bounced back, fuelled by what some called the central bank’s “fanatical debasement of money”, this letter hypothesises that the global macro conditions are ripe and considers five reasons to make the case for gold to perform well in the next few years.
First, the almighty U.S. dollar. Gold has an inverse relationship with the dollar. As the world’s reserve currency goes up, investors mark down the yellow brick accordingly. As the revival of the American economy ensued in recent years, the dollar strengthened. The pandemic momentarily led to dollar shortages as institutions rushed to the greenback for funding needs. All assets were dealt a deflationary shock mixed with a liquidity squeeze. But this is unlikely to endure as a strong dollar would create a major headwind to any American government effort to boost growth and aide the recovery. And with an unprecedented stimulus, a dollar collapse may be inevitable, and gold may flourish.
Second, is inflationary expectations and interest rate policy. For most of the central banks in the West, interest rates hovered around zero for years in response to a fall in prosperity in the wake of the 2008 financial crisis and the European debt crisis that followed. Unlike treasuries, gold offers no yield on investors’ money, so there is an opportunity cost of capital tied up uselessly in bullion than elsewhere. But that has changed. As economies are crippled around the world, most central banks have retreated to near zero interest rates on fears of rising unemployment, deflation and an inevitable recession. Even the prospect of sub-zero rates comparable to Europe and Japan is not far-fetched. And as rates are likely to remain low for the foreseeable future, gold looks as attractive as ever.
Third, is quantitative easing, a euphemism for central banks injecting money supply into economies. Primarily done through buying of government bonds and financial assets, this drives up asset prices, encourages lending and investment. In the immediate term, this helped stock markets boomerang since the March crash. In fact, the price of everything went up staying true to the adage that a rising tide lifts all boats. This unlimited stimulus, which in America has reached $2.7 trillion so far included backstopping corporate bond markets and head-scratching purchases of junk bonds, depends largely on what happens from here on. If covid-19 continues to flare and economies halt any restriction-easing or even prolong lockdowns, expect central banks, especially the Fed to stay true to its “whatever it takes” rhetoric and continue money printing. This debasement should see increased demand for gold.
Fourth, is the supply and demand. Gold nowadays is bought by a far more diverse set of consumers and investors than at any time in history. Not only does it have emotional and cultural value, namely in China and India, the world’s two most populous places, but there is a magnetic shift of demand for gold moving East to societies growing in affluence. China has a combined affinity for gold and a penchant for saving while India has a deeply rooted culture driven by tradition, festivals and societal occasions. Demand will be offset in the short term as global commerce tightens, of which jewellery making for example is not immune. For India, the world’s fastest growing economy, one driver of demand depends on whether its 500 million young people hold similar beliefs about gold to previous generations, or would rather spend their precious rupees on designer bags and smartphones.
Finally, there is geopolitical risk. More simply put, gold performs when fear hits markets. And with a 24/7 news media that has a voracious appetite for sensationalism, fear sells. The last decade we have seen the ongoing battle between America and China weaponizing tariffs in a fight over world dominance, the dislocations in the Eurozone, and destabilisation of the Arab world to name a few. All these events can disrupt global trade, investment and capital flows. Threats alone often deliver immediate shocks to markets and gold prices that can reverberate for some time. As the world descends into dangerous grounds of rising inequality, escalating conflicts, climate change politics and an eroding commitment to the rule of law in the Middle East, it sets the stage for ongoing geopolitical tensions, where gold will have its opportunity to shine.
General Cortés may have laid wondering in his death bed at the plight of the modern day, a world suffering from its own disease that has forced millions into lockdown, paralysed markets and shut down economies. Perhaps the conquistadors were right. Maybe it is time to be obsessed with gold.
_
30 May 2020
Boris Bosanac
PINETA CAPITAL
