Why gold prices are getting a big boost from coronavirus

Peter Cooper compares today's higher prices with those seen after the global financial crisis of 2008-09

FILE PHOTO: A gold ingot and gold coins are seen in this illustration picture taken November 17, 2017. REUTERS/Eric Gaillard/Illustration/File Photo
Powered by automated translation

Gold prices closed last week at seven-year highs and are set to head even higher. Even if the stock market’s sell-off and rally is followed by another fall – similar to the pattern seen during the 2008-09 global financial crisis – gold prices will not suffer a further significant reversal.

It is not too early to buy shares in the precious metal producers, even if the biggest stock market rally for 46 years last week turns out to be a mammoth dead cat bounce.

Precious metals offer considerable upside potential at a time when few other safe havens are available to investors, and acts as a classic hedge against a likely second leg in the bear market.

For those who track the progress of the yellow metal, gold for June delivery closed last week at $1,740 an ounce, while the spot price for the metal was $1,685.

Usually the gold spot and futures price trade within a few dollars. This divergence of the two prices gives traders a clear indication of where the price is going next: up.

If you look back at the financial crisis, gold prices zoomed higher from mid-October 2008 after the US Federal Reserve acted to stimulate the country's economy with its so-called $700 billion (Dh2.57 trillion) "big bazooka". Global stock markets also rebounded in a fashion similar to the rally last week.

But stock indexes then crashed again until finally bottoming out in March 2009, more than 50 per cent off their all-time highs. Gold prices, on the contrary, did not plunge again after the initial 2008 sell-off, and carried on up and up to a new all-time high in 2011.

Will it be different this time? Probably not. The Fed has just delivered what some commentators dub an "atomic bomb" with other major economies also adopting record stimulus packages.

The International Monetary Fund's Fiscal Monitor set to be published next week details stimulus measures amounting to $8tn being taken by global governments.

The IMF itself has opened a $1tn line of new borrowing facilities, and the European Union signed off a $590bn emergency programme last week.

Investors and speculators in precious metals have not forgotten what such stimulus programmes mean for gold and silver prices. Basically the world is printing money and that devalues paper currency. Meanwhile the supply of monetary metals remains almost static, and so their price goes up.

Exchange traded funds used to hold gold by asset managers, hedge funds and private investors added 151 tonnes in March, according to the World Gold Council. Total ETF gold holdings reached a record high of 3,185 tonnes worth $165bn at the end of last month.

Demand for gold coins from the US Mint soared 11-fold in March to 142,000 ounces, a surge in retail demand that may only have just started. Many online bullion dealers are completely out of stock.

However, the coronavirus is a unique crisis. This is not an exact copy of 2008-09. Gold buying by Chinese consumers, for example, has crashed because their retail outlets have been closed.

The Russian central bank has stopped all of its gold purchases because oil prices have cratered following collapsing demand as people stay at home. There is talk the bank might have to sell gold to help close the gap.

That said, gold is a relatively tight market and its supply is also affected by the pandemic. Many mines around the world have shuttered to protect miners and their families from the disease.

A big shift in portfolio allocation towards precious metals – as protection against the expected depreciation of currencies and inflationary impact of budget deficits – on a scale not previously seen outside of wartime will more than compensate for less significant market factors.

But investors should also consider buying the shares of companies that produce gold and silver. Again, look back to autumn 2008 and note how these stocks did not follow the rest of the stock market into a second down leg.

Market leader Newmont Mining (NEM), for example, saw its shares dive with the general stock market until mid-October 2008 and then kept on rallying higher when the market crashed again in early 2009.

Therefore, it is not too early to buy shares in the precious metal producers, even if the biggest stock market rally for 46 years last week turns out to be a mammoth dead cat bounce as it was in 1974. For ETFs, try GDX and SIL that provide a diversified stock portfolio at low cost.

Personally, I am not convinced this global stock market rally can hold. The scale of the economic damage caused by the coronavirus movement restrictions is so big that it's hard to see how near record stock market valuations can possibly be maintained.

Stimulus packages are essential but not omnipotent in the face of record unemployment, business shutdowns, collapsing global domestic product and serious economic dislocation.

However, if these observations about precious metal prices prove correct then you don’t actually have to take a view on where the stock market is going next. The outlook for gold and silver prices is already decided by the trillions of dollars of stimulus in the pipeline.

Peter Cooper has been writing about Gulf finance for more than 20 years