The COVID-19 pandemic has caused investors around the globe to ditch risky assets in favor of safer alternatives. Many have looked to gold as a place to park capital in hopes that the commodity will gain value during the current market rout. This comes as no surprise: Most investors would point to gold as a safe haven, expected to deliver a degree of protection when equity markets become more volatile.
But is it fair to expect so much from a glittery metal that provides no cash flow? Gold wasn’t much of a help in March. US dollar prices in London failed to gain value based on the closing price set by the London Bullion Market Association, which is regarded by many as the official price of gold. Worse yet, the metal moved in tandem with equities during the month’s biggest drops, declining in value along with stock prices. Why isn’t this supposed safe haven behaving as investors might have hoped?
Equity and gold prices moved together during the big declines in March
Sources: S&P Dow Jones Indices, London Bullion Market Association, Bloomberg, 3/31/2020
Dollars and consumers dampen gold demand
There are a number of possible reasons gold didn’t rally in March. One theory is that investors have indiscriminately sold any liquid assets to fund margin calls or cover losses on other risky positions. March’s major equity sell-off not only put a lid on gold prices, but it drove erratic behavior in US Treasuries: the 10-year yield first declined during the month before backing up mid-period as investors dumped Treasuries as well. It seems risk-off sentiment has heightened to the point that investors view cash as the safest haven of all.
A second theory concerns the fact that gold is generally priced in US dollars. Because the US dollar is also viewed as a haven asset, it generally experiences substantial demand during periods of heightened market volatility. We’ve seen that occur this year in reaction to COVID-19: Investors pushed the Bloomberg Dollar Index, which measures the greenback against a basket of global currencies, up to a record high on March 20. An appreciating greenback causes the price of gold in other currencies to go up for would-be buyers around the globe, which reduces demand for the metal.
A third theory focuses on the heavy influence of global demand for jewelry, which accounts for almost half of total gold buying. During periods of economic contraction, demand for jewelry and other luxury items takes a huge hit, since consumers are forced to cut back on discretionary spending in favor of basic necessities. Global demand for gold is likely to take a big hit from multi-decade low growth projections for China and India, the world’s two largest gold consumers. Even though demand from haven seekers may pick up during these periods, it’s often not enough to match the fall from the largest source of consumption.
Could central banks make things worse for gold?
A final factor to consider is that central banks, mainly in the emerging markets, have been large buyers of gold over the past few years; they were in fact the second-largest purchasers in 2019, according to the World Gold Council. Since 2009, official holdings have increased over 5,000 metric tons, which is about one-sixth of what’s been mined since then. If you consider all the gold that’s ever been pulled out of the earth, central banks own about one-fifth of it.
This could be a problem for the gold market if central banks ever become net sellers or even if some of the largest buyers were to halt their purchases, which Russia recently decided to do. One way that could materialize would be if central banks need to access foreign currency to manage their balance of payments. With exports for many countries falling amid the demand destruction of COVID-19, access to hard currencies like US dollars is becoming more scarce, which could force some central banks to sell gold to gain access to greenbacks.
The bottom line
It’s impossible to say where gold prices might go from here. That doesn’t mean the metal doesn’t belong in a well-diversified portfolio given its low correlation to more traditional assets such as stocks and bonds. Investors should keep in mind that the metal is best suited as a long-term strategic holding—not a short-term life preserver when markets get choppy.
Greg Liebl, CFA, Senior Investment Strategist
Greg drives strategy evolution across Parametric’s Emerging Markets, International Equity, and Commodities strategies. Since joining Parametric in 2010 (originally as an employee of the Clifton Group, which was acquired by Parametric in 2012), Greg has provided portfolio management in the areas of risk and exposure management and customized implementation solutions. He earned a BS in business administration with a finance concentration from North Dakota State University. He’s a CFA charterholder and a member of the CFA Society of Minnesota.
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