Billions into bullion – a safe haven amidst the chaos

Summary: Caught between its safe-haven status and a broad sell-off in all asset classes, gold has been exceptionally volatile since mid-February. After reaching its highest level since late 2012 in early March, it fell alongside risk assets, only to rebound heading into April. Gold gained support as investors looked to it as a safe-haven after the recent losses in stock markets, along with increased expectations for more moves by global central banks and financial policy makers to boost the global economy.

Gold market disruptions

Gold typically acts as a hedge, but fell alongside other risk assets in March, and some started to question if the precious metal had lost its safe-haven status. There are a number of possible reasons why gold didn’t rally in March.

• Firstly, some investors were obliged to sell liquid assets, such as gold positions, to raise cash to fund margin calls or cover losses on other risky positions.

• Secondly, it seems cash was seen as the safest haven of all, with investors also dumping US 10-year Treasuries at the same time. Gold is priced in US dollars. The US dollar is also seen as a safe-haven during periods of heightened market volatility – an appreciating greenback causes the price of gold in other currencies to go up, which reduces demand for the metal.

• Thirdly, it was hurt by the fall in oil prices, as it brought Russia’s Central Bank purchases to a halt. Emerging market central banks have been large buyers of gold over the past few years, and were the second-largest purchasers in 2019, according to the World Gold Council. If central banks become net sellers or if the largest buyers were to halt their purchases, this could be problematic for the gold market. COVID-19 has led to a fall in exports for many countries, and as such access to hard currencies such as the greenback are becoming more scarce, which could force some central banks to liquidate gold positions to gain access to US dollars.

Supply chain disruption:

Disruptions to supply chains have further complicated the movement of gold prices. In late March, there were fears that there would not be enough physical supply of 100 ounce gold bars required to keep pace with demand. For the first time in 100 years, three large refiners in the Swiss canton of Ticino (Europe’s biggest gold-refining hub) temporarily closed, alongside supply from gold mines being disrupted and the grounding of passenger airlines that usually transport gold between international markets due to government lockdowns – creating a price-boosting shortage of gold bars and coins.

Open gold contracts on the Comex exchange in the US far exceeded the volume it held in warehouses – which led to a price premium of as much as $100 in New York above London’s spot price, due to fears of a lack of physical metal to settle the contracts. The gap is usually a couple of dollars. Adding to the difficulty, Comex’s main gold futures run on 100-ounce bars, meaning 400-ounce bars from London must be melted down and recast, usually in Switzerland, before shipping to New York. This dislocation affects the entire gold supply chain as companies use futures to hedge their exposures.

Whilst a lack of liquidity widened price spreads during March, more gold was on its way to New York in April replenishing stockpiles, as traders holding gold futures rolled over their paper contracts to the next expiry date, averting a major shortfall in delivery. The partial reopening of several refiners also helped increase supply, allowing the market to return to focusing on fundamentals. The LBMA (London Bullion Market Association) and CME have reassured the market that they are actively taking measures to ensure the continued efficient operation of global gold markets during this unprecedented time, by working with banks, refiners and shippers to overcome travel constraints and ensure the physical movement of metal via chartered or cargo flights. The CME has also introduced a new physically-delivered gold contract that will enable delivery of 100 ounce, 400 ounce or 1 kilogram bars to provide the market with more flexibility.

Factors supportive of gold

1. The intervention of governments and central banks to “do whatever it takes” through enormous monetary and fiscal stimulus packages is supportive of gold. Unlike dollars or indeed other currency, governments and central banks cannot print more gold. As a result, it holds its value and is seen as the antithesis to fiat currencies. With global interest rates at low or negative levels, central banks resuming QE and injecting unprecedented liquidity to help bolster a fragile economy, gold’s potential as a long-term store of value and hedge against inflation has garnered interest again. Since bonds pay a yield and gold does not, when bond yields are high investors tend to prefer them. But as bond yields fall or indeed turn negative in real terms, offering returns that don’t keep up with inflation, the opportunity cost of investing in the yellow metal starts to diminish.
   
   
2. The numbers of retail investors seeking to purchase physical gold has increased significantly, but with disrupted supply chains and therefore pressure on refineries to meet surging interest, the COVID-19 lockdowns are likely to continue to put pressure on supply and thereby pushing prices higher. It is likely, however, that uncertainty and its economic impact will have a negative impact on gold demand for jewellery. Despite this, investment demand could more than offset a reduction in consumer demand, at least in the near term.
   
   
3. Even once we move to some state of normality from the lockdowns, the severity of economic impact could also provide support for the yellow metal in the longer term.
   
   
4. Gold is the only asset without counterparty risk, and can help protect against currency devaluation as central banks continue to flood markets with liquidity to combat the economic impact of COVID-19. These stimulus policies could prove inflationary – while inflation did not materialise after the global financial crisis in 2008 as many gold investors had hoped, this time could be different.