UNLIKE what many may perceive, a rise in gold price is actually a reflection of the poor state of affairs in the underlying economy.
Gold is a flight to safety when there are fears of the economy going into a period of stagflation. It is a period when there is high inflation, high unemployment, low economic growth and low demand.
Fears of the world, led by the US, which is the largest economy, going into a stagflation is the primary reason for the sky-rocketing price of gold.
The Federal Reserve has been on a bond-buying programme to keep the economy and companies afloat. This has caused the 10-year US treasury bond yields, which is the benchmark for debt papers, to be at an all-time low.
Unemployment is creeping up again due to companies being shut down or downsized due to the Covid-19 pandemic. Malaysia’s unemployment numbers are at 5.1% in the second quarter and expected to go higher.
All countries have recorded a steeper-than-anticipated decline in the second quarter economic growth, suggesting that recovery may not be immediate.
Malaysia’s gross domestic product was a negative 17% in the second quarter. Bank Negara has forecast Malaysia’s economy to decline by up to 5.5% this year, which is worse than the previous prediction of negative 2%.
According to the International Monetary Fund, the US economy is expected to decline by 5.9% this year, after it recorded a negative 9.5% decline in the second quarter, which is its worst in recent years.
Yet, the gold price is on the rise. Price of gold is up by 26% in the first half of this year, hitting a new high of US$2,061 an ounce on Aug 7 before settling hovering around US$1,950.
The disparity between the rising price of gold and fears of the economy going into a tailspin is reflected by the poor sales of jewellery.
Investments in jewellery, gold bars and coins are sharply down. According to the World Gold Council, investments in gold bars and coins slowed sharply in the first half to 396.7 tonnes, which is a 11-year low. As for jewellery, demand fell by 50% to 572 tonnes in the first half of this year.
In normal times, almost 65% of demand for gold comes from people wanting to buy jewellery, gold bars and coins. But the weak economic outlook and uncertainty have caused fear among consumers. Even India where demand for gold is always high has seen a significant drop in sales.
The beneficiaries of rising gold price are the gold-backed exchange-traded funds (ETFs) and gold mines.
Gold ETFs offer investors an option to invest in physical gold at a fraction of the price and at the same time gives them an opportunity to cash out easily. Malaysia has a listed gold ETF which is up by more than 25% year to-date while there are a few listed in Singapore.
The demand for gold is largely up by the inflow of funds into gold-backed ETFs. This is because gold ETFs back up part of their assets under management by buying physical gold with 99.5% purity.
Inflows into gold-backed ETFs jumped in the first half of this year to 734 tonnes, surpassing the previous record of 646 tonnes registered in 2009. According to the World Gold Council, global holdings of gold held by ETFs reached an all-time high of 3,785 tonnes in July this year, backing US$239bil assets under management of gold ETFs.
As for gold mines, interest picked up following Berkshire Hathway’s purchase of a stake in a gold mining company last week. Bershire Hathway, the investment arm of renowned value investor Warren Buffett, traditionally stayed away from putting money into gold because it does not yield any dividend.
Buffett’s investment in gold is seen as a sign of the weak outlook of the US economy.
Gold is the second safest bet against inflation and economic turmoil after government bonds. Government bonds are the best bet as it gives a yield. But when there are expectations of inflation creeping up, the real returns from bonds may turn out to be negative.
The situation today is similar to what happened between 2009/2011 when the US dollar weakened on the back of the Federal Reserve printing money to keep the US economy afloat.
There were fears of stagflation, which resulted in gold prices rising almost 100% from August 2009, hitting a high of US$1,900 per ounce in 2011. When fears of stagflation dissipated, gold prices fell by almost 50% to a low of US$1,061 in August 2015.
In January this year, the Federal Reserve started to reduce interest rates. The Covid-19 pandemic forced the Federal Reserve to issue bonds to help the corporations in the US.
The weak dollar followed by the inflow of money into gold ETFs due to fears of stagflation has given gold the boost.
It’s hard to see stagflation happening. With governments printing money and technology raising the level of productivity, economic growth will certainly come back. Inflation also has been fairly contained due to technology that has generally lowered the cost of doing business.
The economy will surely pick up when the US gives the green light for a mass-production of a vaccine for Covid-19, that may be as early as November this year. Inflation is unlikely to be high even with all the money printing activities by central banks.
History has shown that fears of a stagflation always slide away and gold prices come down when the economy recovers. It’s only a question of time.
Until then, there really is no rush to buy jewellery.
M. Shanmugam is former specialist editor of The Star. The views expressed here are solely that of the writer’s.
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