Gold Bugs

Amidst growing global uncertainty, the gold price has seen a strong rally so far this year. The trade tensions between major economies (most notably the US and China, and to a lesser extent the US and EU) continue to ebb and flow, Brexit remains ambivalent (it may once again be delayed, beyond the 31 October extended deadline), while there are mounting worries about a slowdown in global growth.

These events have led to increased demand for the ‘safe-haven’ commodities, resulting in an exciting run in recent months for gold and silver. The spot price for gold recently reached a new high for the year, trading at US$1,555.07 per troy ounce – hitting the highest levels since 2013. The recent spate of rand weakness saw bullion reach new all-time highs in rand terms. The surge in price provided relief for South Africa’s active gold producers, whose share prices were lifted by the gold rally after a period of protracted labour disputes and weak output (Ghana has now overtaken South Africa as the continent’s largest producer).

Source: Bloomberg

Why exactly is gold such a popular hedge against uncertain times? Humans have placed value on the precious metal as a medium of exchange, which led to the advent of currencies which were backed by reserves of gold (the gold standard). This was effectively abandoned by 1971, leading to our current fiat money system – currencies backed by a government guarantee rather than having their value linked to any specific asset. Gold’s value, however, lies in its scarcity. It is sufficiently abundant that it can be used as a medium of exchange, but scarce enough to give it value, while also being non-corrosive. Societies have placed value on the metal, and in order to increase supply it must be mined and processed, whereas supply of fiat currencies can be increased through printing more fiat currency (which can have disastrous consequences, as seen in Zimbabwe and Venezuela).

The seemingly endless trade war keeps investors on edge, as new tariffs are threatened (and sometimes introduced), followed by reports of negotiations or talks (which ease concerns somewhat), before the cycle starts again. There are also concerns about China’s slowing growth – while not moving into a recession, slower growth results in less demand for commodities and therefore lower commodity prices. This, in turn, impacts commodity exporting nations such as Namibia who face the prospect of reduced exports at lower prices (hampering the growth prospects for these exporters).

There are also concerns of recessions in major economies, most notably Germany, the UK and the US. Many are anticipating a recession in the US, owing to the fabled inversion of the yield curve. More recently the US PMI (purchasing managers’ index) fell below 50 for August, signalling a contraction and putting it in line with other countries such as China, Germany and the Eurozone.

Source: Bloomberg

Despite the surge in the gold price, some anticipate that the more accommodative stance by the US Fed will further bolster the commodity’s price. The market is now anticipating the Fed rate cycle to include four cuts by the end of 2020, with the first one as early as September this year, in order to combat slowing growth in the US and reduce the full impact of the trade war with China. This benefits gold, as lower nominal rates would reduce the real rates that investors receive, making it more attractive to hold gold – especially in an environment with high uncertainty as is the case presently.

While it is difficult to be certain at which levels and when the rally will end, precious metals appear to be doing what they should be doing: acting as a hedge against (economic) instability.