Gold finished its 2018 run at around $1300 an ounce; by late August 2019, the price was already at its 6-year high of $1525, having grown by circa 20%. By the end of 2019, the price hovered around $1475. The key drivers of the rally included the US-China trade war, Brexit uncertainty, tensions in the Middle East, and the impeachment of Donald Trump.
In 2020, global economy growth rates will likely keep decreasing. We are now in the downward phase of the current economic cycle, exacerbated by the high level of geopolitical instability. These factors will keep supporting the investment demand for gold. The following economic and political circumstances act as the fundamental growth drivers for the yellow metal:
The global volume of negative-yield state bonds has reached $14 trillion. In this context, the fact that gold doesn't yield any interest makes it a profitable asset, granted that its price in various currencies increases.
Central banks are unable to improve growth rates. For instance, in the US, reversing the downturn would entail reducing the interest rates by 3%. Since the current level is of 1.5%, the resulting rate would be negative.
The rising wave of populism. This phenomenon isn't limited to the US only. In Italy, France, and the UK, a large percentage of the population supports candidates with openly anti-immigration, nationalist, and protectionist programs.
The US dollar is gradually losing its status as the dominant global reserve currency. Many countries seek to diversify their reserves, exiting USD and stocking up on gold. Global instability has led to a reduction in risk-adjusted returns on traditional assets. In turn, this has caused a decrease in capital investment alongside a surplus of savings. This creates advantageous conditions for the gold market in developed countries.
In 2020, central banks in developed countries will likely continue reducing their interest rates, just like they did in 2019. The factors that we have listed can push the price of gold all the way up to $1700-1900 an ounce over the next 12 months.
The fall in interest rates caused a decrease in the yields of state bonds. This was a boon for alternative diversification instruments such as gold, whose price moves in the opposite direction relative to the real returns on bonds. In the short term, the correlation between gold and stocks varies depending on the correlation between stocks and USD, whereas in the long term, gold has a negative correlation with stocks. The combination of low interest rates and negative-yield bonds makes gold more attractive to investors, thus reducing the opportunity costs of owning an asset that doesn't yield any interest.
In the context of a long investment horizon, gold is an effective diversification tool. If you analyze the 5-year returns on gold and S&P 500, you'll find a negative correlation. For example, in the 70's and in the 2000's, the price of gold grew while the S&P 500 index fell. This relationship isn't surprising by any means. After all, gold serves as a traditional hedging asset in presence of systemic macro risks that can lead to prolonged periods of low returns on stocks. Because of this, now is a good moment to add gold to your investment portfolio, considering that low macro volatility in the 2010's will likely be replaced by high volatility in the 2020's.
In 2020, global political instability will be significant. The ongoing conflicts between the US and Russia, Turkey and Iran are unlikely to be resolved. In addition, we are witnessing a surge of mass political and environmental protests, such as those in Hong Kong, Chile, some European countries, alongside Russia. Moreover, economic inequality is becoming an ever more urgent issue in many regions. That's why some of the US and UK election candidates promote aggressive fiscal measures combined with programs of wealth redistribution. Several of the US presidential candidates have proposed to introduce a new tax on the rich and to roll back the corporate tax reduction passed in 2017.
At the same time, several Eastern European countries that have been experiencing tensions with the EU due to their internal policies, have now increased their gold reserves, repatriating them from the Bank of England. The countries hit by US sanctions are also building up their gold reserves. This isn't unexpected: geopolitical instability usually leads to an increase in the demand of gold. Therefore, central banks around the world are now busy buying up gold.
2019 was a record year in terms of gold purchases by central banks, with circa 700 tons bought in total. The demand will likely remain high in 2020, considering the current level of geopolitical uncertainty, low interest rates and the little share of gold that developing countries hold in their reserves. Continuing de-dollarization and the build-up of gold reserves by central banks will drive the gold market in the mid-term. We should also point out that in developing countries, central banks have been net buyers of gold for 10 years in a row – this is the first time this has happened since the creation of the Bretton Woods agreement in 1944.
Additionally, there are many reasons arguing why gold is gaining popularity as a reserve asset. These include: 1) The central banks' need to increase their holdings and diversify their portfolios; 2) High liquidity on the financial market; 3) The improved position of gold (Tier-1, or “riskless asset”) under Basel III; 4) The use of gold as collateral in borrowing and leasing markets; 5) The overall absence of credit risks. Moreover, global tariff wars, the US sanctions policy, and de-dollarization trend should support and further encourage the central banks' demand for gold.
The price of gold will keep growing as long as the real returns on traditional assets remain negative or low – and as long as economic instability holds sway. In 2020, gold can grow up to $1600 or even $1700 an ounce if the geopolitical conditions keep worsening.
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