Yes, investors who have made tactical bets in gold should consider scaling back their positions and locking in some gains. The recent gold rally has been swift, with prices surging to all-time highs. While any decision to trim should also consider the asset owner’s risk tolerance, we believe investors would be well-served by exercising caution with gold at these levels.
Gold has enjoyed a stellar rally thus far in 2020, outperforming all major asset classes. The price of the metal has gained 30% year-to-date and 23% since March, its sharpest four-month gain since November 2009. COVID-19 and the policies governments have adopted to offset the drop in economic activity are primary reasons behind gold’s recent rally. Indeed, as global central banks unleashed unprecedented policy measures aimed at curtailing the fallout from the pandemic, a confluence of factors created a perfect storm for gold prices: real yields plunged, the dollar came under pressure, and inflationary fears resurged.
The gold price rally has also defied a significant downturn in consumer demand for physical gold. Jewelry demand, which is typically a relatively stable component of global gold demand, plunged 46% to 572 metric tons in first half 2020 as the impact of the pandemic weighed on consumers. China and India, the world’s top gold consumers, saw a major pullback in demand as disposable incomes fell. However, the slump in consumer demand was more than offset by surging investment demand, as gold-backed ETFs saw inflows equating to 734 metric tons of gold in six months, exceeding the highest annual ETF flows on record. Speculative non-commercial net positions are also elevated relative to history.
Movements in real yields have been a major driver of gold prices in recent years. Gold prices have an inverse relationship with real rates, in part because lower rates reduce the opportunity cost of holding gold (which offers no yield). As such, the current ultra–low rate environment has been a key supporting factor for the gold rally. Thus, the forward path of real yields will likely have a strong influence on gold. Widening inflation expectations and accommodative central bank policies could continue to keep real yields depressed in the near term, but investors should be aware that signs of economic optimism could drive real yields higher and acutely reverse the gold price rally. For this to occur, expectations for real growth and the term premium would have to increase by more than inflation expectations.
Recent increases in the number of coronavirus cases have unsettled markets, rekindling fears of a prolonged economic downturn. This heightened uncertainty has undoubtedly played a role in the surge in gold demand, as investors braced for worst-case scenarios. But gold prices are likely to peak when investor anxiety hits a climax. In other words, any positive surprises related to vaccine developments, treatments, containment, or government support for economic activity are likely to put downward pressure on gold prices.
Still, we remain supportive of holding a small amount of gold in a diversified investment portfolio. We acknowledge that gold prices could continue to run in the near term on the heels of recently surging momentum. Moreover, new concerns about a volatile US election process and the potential for future dollar weakness could keep gold prices well bid. However, gold prices are notoriously fickle, and getting the timing right is a difficult exercise. With prices at all-time nominal highs, we think investors should consider taking a portion of these profits off the table.