Several notable people in the gold mining industry have told me over the years that anyone who claims they can predict the price of gold is either a fool or a liar. I agree in general, but with all due respect, I must bring certain nuances.
This brings me to the subject of this blog. Gold is trading at $1,731 an ounce, up 29% over the past 12 months, including 14% this year. Can it hold at those levels and is there room to climb further? I believe the answer is yes.
Even before the COVID-19 pandemic hit us, many of the factors positively impacting the price of gold were in place: low-interest rates globally, high debt levels, easing monetary policies, central bank buying, ongoing trade tensions between the United States and China, and mass economic protests in many countries around the world.
Fiscal stimulus measures introduced around the world will be financed by deficits and debt, which means that debt to GDP increases while GDP decreases. This trend will continue for the foreseeable future, which creates a favorable environment for gold.
As the economy struggles to show growth, more and more countries are turning to negative interest rates to stimulate spending and consumption. Total negative-yielding debt around the world has increased substantially. It’s fine for governments to borrow at low-interest rates, but eventually, the debt will have to be repaid, or a default will occur, or something else will happen.
These fiscal stimulus measures and unprecedented government debt have pushed the price of gold to record highs in several currencies and bolstered demand for gold ETFs. Yet the price of gold does not fully reflect what has happened and the global financial strains to come. The price of gold stocks is even less representative of the current situation.
There are three fundamental reasons for believing in a rise in the price of gold in the short term and immediately. First, real interest rates will likely remain low to negative for some time, supporting demand for gold as an investment. Additionally, demand in emerging markets will likely increase as these markets return to some degree of normality. In my opinion, this demand, especially from China, did not dissipate, it was simply suppressed for a while.
Second, if we look beyond the likely immediate deflationary effects of COVID-19, there are factors supporting higher inflation, which is also supporting the price of gold. I believe there will be lasting disruptions in supply which, even with weaker aggregate demand, will cause an imbalance in favor of demand, which will have an inflationary effect. We are also in a period of unprecedented government fiscal and monetary stimulus, which will devalue the purchasing power of currencies and will likely cause inflation.
And, finally, we come to the issue of debt. The policy objective of encouraging higher inflation to support the sustainability of unprecedented debt levels cannot be overlooked. It’s a much better alternative to default. Therefore, there is some political expediency in supporting higher valuations for assets that underlie debt that cannot be repaid.
These factors convincingly demonstrate that investing in gold as a physical asset, a currency whose value cannot be downgraded, is a good idea. However, there are other things to consider. Investing in gold as an asset class can be a great value proposition. Investing in gold stocks, especially in a rising gold price environment, might be a better way to gain exposure to gold. Stay tuned for more on this.