That “sound you hear is thousands of gold bugs cheering”, says Tracy Alloway on Bloomberg. On Monday the precious metal finally surpassed its 2011 peak of $1,923.70 an ounce to set a new all-time high in dollar terms. In sterling, the yellow metal has long eclipsed its 2011 levels and was trading above £1,500/oz this week, marking a gain of 29% in 2020.
Falling real interest rates
Gold arouses strong emotions, says Russ Mould of AJ Bell. Bulls love the protection it offers against “unforeseeable disasters”; critics deride it as a “barbarous relic”. The bugs are in the ascendant now, and there is no shortage of things to worry about.
Global instability; a possible descent into a deep recession and deflation; and the prospect of more quantitative easing and a surge in inflation have been keeping people awake at night for years now.
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The proximate cause of the latest rally, however, has been tumbling real (inflation-adjusted) interest rates. For example, the nominal interest rate on a ten-year US Treasury bond is currently about 0.6%, but take away expected inflation over the period and the “real rate” is closer to minus 0.9%.
Low real rates are due to two key factors: first, low headline interest rates. Global central banks slashed rates in the face of the pandemic earlier this year. In many countries they are near or below zero.
Second, rising inflation expectations. Market expectations of US inflation over the next decade plunged in March but have ticked up recently and currently sit at around 1.5%. This is likely to be “intentional”, as Sam Goldfarb points out in The Wall Street Journal. With little room left to cut interest rates, central bankers are now stoking inflation expectations in order to drive down real rates. That also helps reduce our huge post-pandemic debt load. Gold’s biggest drawback is that it pays no interest, but negative real rates mean that other safe assets (especially bonds) offer an even worse deal. Investors are thus flooding into gold.
Plenty more to come
Some will wonder whether it is too late to buy in, says Adrian Lowcock of Willis Owen. Sadly, the current crisis is “far from over”. Even more monetary and fiscal stimulus is likely, weakening fiat currencies and risking an eventual inflationary spike. As gold is priced in dollars, the falling greenback is also helping (it makes gold cheaper in other currencies).
The Pure Gold Company reports a 1,104% surge in demand over the last two weeks, including a 687% increase from financial professionals. Fear of a second virus wave in Britain, coupled with Brexit jitters and rising US-China tension, make for an unstable backdrop, says CEO Josh Saul. Gold is insurance; “the higher the risk the more expensive the insurance”.
“Almost every box” is ticked off for gold to go higher, says Edward Moya of Oanda. Fears of a second wave and more stimulus? Tick. The dollar in “freefall”? Real rates tumbling? Geopolitics worsening? Tick. Tick. Tick. The rally might “take a break”, but all eyes are now on the $2,000/oz level.
Silver starts moving
If gold is the “money of kings” then silver is “that of gentlemen”, says Ned Naylor-Leyland of Jupiter Asset Management. The two precious metals are “siblings”.
While the gold rally has grabbed the headlines, silver has gained 36% in the last month alone. It reached $24 an ounce this week and was close to £19/oz in sterling terms, a seven-year high. The pace of recent gains has been frenetic, with silver jumping by 15% last week.
The rally has been driven by similar forces to those pushing gold higher: falling real yields and a growing desire for a safe haven. Yet the recent price action is a reminder that silver is a much more volatile commodity than gold. Silver tends to follow gold, but at a “lag”, says a recent Goldman Sachs note quoted by Krystal Chia and Ranjeetha Pakiam on Bloomberg. Typically, a gold rally gets underway first, then gold bulls, looking for a way to diversify their bets, turn to silver. The metal has been trading at “close to a record discount” to the yellow metal this year but is now stepping “out of gold’s shadow”. The gold/silver ratio certainly suggests further upside, says Naylor-Leyland. In 2011, when silver hit a record $49.50, you needed 32 ounces of silver to buy one ounce of gold, yet that ratio has expanded to approximately 80.
In addition to being a precious metal, silver is also used in industry, including fast-growing areas such as solar panels, 5G networks and 3D-printing. Around half of silver demand stems from industry. Supply constraints are proving another tailwind, says Clara Ferreira Marques on Bloomberg. Latin America is the world’s biggest silver miner, but virus-linked closures in Peru and Mexico should see production fall by 7% this year according to figures from The Silver Institute. There is “room for silver to keep shining”.
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