Gold is a strange commodity. While it has some industrial uses, it mostly ends up in jewelry or money-surrogates such as coins and ingots; the latter often in central bank vaults. Unlike other metals, it accumulates and circulates in the economy and society; it is not sequestered in buildings, vehicles, machinery, instruments, wiring, cables, or devices (except for a small but important portion that goes into electronic products). It also does not respond to the usual economic forces that affect supply and demand for it, and thus, its price.
In the past year, gold’s price, in US dollars, has escalated. According to moneymetals.com, the price per troy ounce (twelve per pound, not sixteen) rose from USD$1,283.10 on January 1st, 2019 to a closing price on December 31st of that year of USD$1,515.60, an increase of 18.1% in just a year. The run has added another hundred dollars or so in this new year.
Strangely, all major asset classes performed well last year: stocks, bonds, real estate, and commodities (including gold and other precious metals). There is only one economic force that can make that occur: financial easing which lowers interest rates and lavishly augments liquidity in the banking system and financial system in general.
That easing has not yet been implemented by central banks such as the Bank of Canada and the Federal Reserve Board of the United States, except for technical purposes in the US (short-term) money markets. It has happened in the bond market as savers, investors, speculators, traders, and hedgers are likely anticipating lower, slower economic growth, increased political uncertainty, and perhaps even a relatively lower US dollar. The reasons for this caution are multifold.
The COVID-19 (novel corona) virus has done major damage to China’s economy. Much of the nation was shut down for weeks. Not only does that mean lower demand for goods and services, which affects the rest of the world, but it means shortages of input goods for many companies around the globe, dampening economic growth further. Tourism to and from China has also suffered.
The drop in economic activity, goods, and people being transported has also caused a drop in demand for oil used in fuelling planes, trains, trucks, automobiles, buses, and ships and barges. This has amplified an already lower capital investment outlook for oil and gas explorers and producers. Those firms and other industrial companies are ordering, purchasing, and producing fewer vehicles, heavy equipment, and other machinery all of which incorporate metals, particularly steel and copper, in them.
At about USD$2.60 per pound, copper is down about 10% since May of last year, according to data from the Wall Street Journal. Much of the gold produced is a by-product of copper production. If less copper is produced, less gold will be too. More importantly, if copper remains relatively depressed, copper and gold mining projects will be postponed, and existing mines may be allowed to deplete. So will nickel projects as stainless steel demand declines.
Precious metals such as platinum and palladium, escalating in price over the past year – which affects gold prices – are produced as by-products along with nickel. Gold buyers may be thinking that this could be a protracted slowdown not just in China, but everywhere. Certainly, growth is dull globally.
The slowdown in China has also increased political turmoil in that nation, as its population rightly wonders whether its ruling elite have done enough, early enough, to mitigate the crisis. Political uncertainty abounds in North America too as Canada is suffering through pipeline and environmental controversy, and the United States, the world’s largest economy, has entered a period of political acrimony and contentiousness.
If the ruling Republican party is reelected, Washington may continue spending at a profligately elevated level, which can only be sustained if interest rates continue to be abnormally low. If there is a mixed election outcome or an outright anti-business administration elected in early November, spending and business confidence may remain subdued or even worsen, making economic growth slow or turn negative.
In either case, it is likely that the Federal Reserve will keep interest rates low and investors will find fewer attractive risk-adjusted returns other than the dismal ones that long term Treasury bonds now provide. In Europe, Japan, and Latin America few nations are growing substantially; interest rates are likely to stay low. There is even the chance that ‘quantitative easing’, i.e., printing of money by central banks to buy government bonds, may resume. The United Kingdom will also face lower investor confidence until its future trade and economic posture become clearer.
Trillion dollar deficits in the United States have now become a matter of course. If long – and short term – interest rates were at their normal level of about three percent in ‘real’, inflation-adjusted terms, they would be around five percent, and not 1.9% for a thirty-year Treasury bond, as they were in trading on Friday, February 21st of this year.
Were the cost of debt servicing to jump to a more normal level, the United States would enter a financial crisis. The investment world knows this, so it assumes that current interest rates, or even lower ones, will continue. The opportunity cost of holding gold bullion is thus lower, making it more attractive relative to bonds, and to expensive real estate and the stocks of companies whose earnings growth – which drives share prices – domestic and international, looks tepid, at best.
As the United States adds to its debt pile, it draws in more foreign capital which raises the value of the US dollar. As more interest gets paid out to foreign investors, downward pressure on the dollar strengthens. In normal times, the increase in foreign holdings will outweigh the rising outward flow of dollars in interest payments. There is some international conflict at present, but not enough to justify fleeing into gold or the US dollar.
However, foreign and domestic investors are looking way beyond this year and seeing a bloated creditor nation, the United States, whose interest rates will be lower for longer either organically, as the growth outlook dims, or artificially as the Fed keeps rates low to perpetuate a very long-lived expansion. If the US dollar does start to decline, or quantitative easing occurs, inflation could resume, which would also bolster the attractiveness of gold as a store of value.
Stocks and bonds may not necessarily be bad purchases for investors today or even tomorrow, but gold is justifiably looking relatively better, which is a sad indication of the political and economic state of the world and its possible dismal, debt-burdened, and sluggish future.
Ian Madsen is a senior policy analyst with the Frontier Centre for Public Policy.