The evolution of gold
Gold has been considered precious throughout history, but it was not used as money until approximately 550 BC. At first, people carried around gold or silver coins. If they found gold, they could get the government to make tradable coins out of it. According to The Balance, Roman Emperor Augustus set the price of gold at 45 coins to a pound in 30 BC. Its value has steadily increased since then, reaching $1 823 an ounce in 2011, before falling to $1 051/oz. in 2015, and again reaching a new high of $2 062/oz. on 7 August last year.
In 1257, Great Britain set the gold price per ounce at €0.89 and revalued it every century until it reached €4.25 per ounce in 1717. This price level was maintained until the 1944 Bretton-Woods Agreement, when most developed countries agreed to fix their currencies against the US dollar since the United States (US) owned 75% of the world's gold at the time. Most countries started printing paper currencies in the 1800s, which were supported by their values in gold. This was known as the gold standard. In 1791 the US set its gold price at $19.49 per ounce after using the British gold standard for years. After the US market meltdown of 1929, which saw investors turning in money for gold as a safe haven, President Franklin D Roosevelt outlawed the private ownership of gold coins, bullion and certificates in April 1933. Americans were forced to sell their gold to the Fed. In 1934 the Gold Reserve Act was passed, which prohibited the private ownership of gold in the US. Courtesy of the act, the US president at the time also adjusted the gold price to $35 per ounce, which remained fixed until it unhinged from the dollar in 1971 following the abandoning of the gold standard.
How is gold used globally?
The use of gold has evolved from predominantly plating and decorations, to include applications in technology as well as being used for investment purposes.
The use of gold in technology includes, but is not limited to, the manufacturing of electronics, computers as well as aerospace equipment. Investors mainly use the metal to hedge against falling real yields, to counteract a declining dollar and offset stock market declines. The introduction of gold exchange-traded funds has also played a huge role in stimulating the metal investment demand by making it easy and cheap to have exposure to the metal and trade it like a normal stock.
Why invest in gold?
If nominal yields do not outpace inflation, real yields turn negative. This will lead to investors losing money in their savings account or when holding treasury bonds. There has been a strong inverse relationship between gold and the US real yield. This is because when real yields are negative, the opportunity cost of holding non-interest bearing gold over income-paying alternatives diminishes. Therefore, in a declining yield environment, investors will prefer holding gold in their portfolios as protection against falling returns.
Gold in the modern era
Since the US gold standard was abandoned in 1971, gold has had two major bull runs, with each lasting over 10 years. The first bull run began in December 1969 and lasted 122 months, after President Richard Nixon took office and later instructed the Fed to not honour the dollar's value in gold. This saw the gold price rallying 1 448% to hit $650/oz. in January 1980.
The second bull run began in August 1999, driven by bulk buying of the metal as major governments around the world imposed radical monetary policies in responses to crises such as the Y2K scare, 9/11 attacks, the global financial crisis, euro zone crisis and the US sovereign debt downgrade. This rally lasted 145 months and saw the gold price increase 616% to reach $1 827/oz. in August 2011.
Gold versus US treasury real yields (inverted)
We are currently in the third bull run, which began in December 2015. This rally has already lasted 58 months with the gold price rising 86%. The surge has been largely due to strong investment demand as investors seek to hedge their returns and their investments against the impacts of US-China trade tensions, a weakening dollar and the Covid-19 pandemic. Whether or not this rally will continue remains a big unknown, but fundamentals remain supportive of a high gold price.
How has gold performed relative to other assets?
Market crises and related policy responses have resulted in gold massively outperforming other asset classes over the past 20 years. We believe the metal will maintain its attractiveness as a store of value and will continue to offer protection against downturns and currency devaluations. Given prevailing global market conditions, we believe gold may continue outperforming other asset classes in the short to medium term.
Gold versus other assets
What about gold's seasonal performance?
The 45-year average monthly gold performance data indicates that March is normally the weakest month for gold, while September is the strongest. We suspect the strong September performance may be driven by Asian countries' pent-up demand in preparation for their respective wedding seasons. Even though past performance is not indicative of future outcomes, we believe this is an interesting trend to monitor and possibly capitalise on.
Gold seasonality
The outlook for gold
Unlike other commodities, gold prices follow a "random walk". A random walk is a statistical phenomenon where a variable follows no detectable trend and moves seemingly at random. As discussed, this is because the gold market operates as a type of insurance against extreme movements in the value of traditional assets during unstable financial markets. Given this price volatility, Elsevier suggests that the best way to predict future gold prices is to take today's price and add a random shock factor to it. The random shock and its magnitude are the biggest unknowns in the forecasting process and may thus significantly impact the accuracy of the price estimates.
While forecasting exact gold prices is very difficult, it is possible to predict directionality. Over the very long-term, gold prices move in a relatively stable fashion and are driven by different factors. Declining gold supply mainly due to increasing mining costs, decreased exploration and difficulties finding profitable deposits play a major role in the metal's price escalations. The liquidity and marketability of gold during unstable financial markets continuously attracts long-term institutional and retail investors who seek to protect their returns when markets are uncertain. This is also conducive for long-term gold price appreciation.
We believe that prevailing risky market conditions, limited returns on global risk-free assets due to accommodative policy, expectations of gradually normalising inflation, a depreciating US dollar, uncertainty around global economic recovery and ongoing geopolitical tensions remain conducive for safe-haven assets such as gold.
