Gold’s $2,000 surge was a 3-step process and the ride is not over

This article appeared originally in Gulf News: link to original article

What is happening with gold is nothing short of interesting.

Whereas the rise in gold’s price from its $1,200 per ounce level in December 2018 to its $1,400-$1,700 per ounce level in December 2019 seemed gradual, the most recent surge wasn’t. The latter points to an underlying shift in financial markets and to a growing sense of uncertainty that clouds the world economy.

Such a shift became apparent as the increase in the price of gold took almost two years to manifest into a price per ounce that exceeded $2,000 at the time of writing, with the increase happening over three stages.

The first took place between December 2018 and December 2019, when the price increased by around 20 per cent from its $1,200 levels to $1,400 and over. The increase was the result of a mix of purchases by governments, through their central banks, and by individual and corporate investors. Looking ahead at the time, the world’s economic outlook was anything but optimistic, and diversifying into gold holdings in an era of low and negative interest rates made sense.

Virus sets off a binge

With the spread of COVID-19, more governments and investors joined in purchasing gold and driving its price from $1,400’s to one that exceeded $,1700. This was the second stage of the increase as the price stabilised around that level until June 2020. For many countries, this was also the forecasted time at which they would have reached or surpassed peak points on COVID-19 cases.

The accuracy of the initial forecast is surely questionable, not only because many countries had not yet passed their forecasted peaks while others are dealing with second waves of cases, but because the price of gold reached an all-time high in modern times. (Analysts calculate previous peaks at higher than $2,000 per ounce in today’s money.)

Some offloading

Anyway, this is the third stage of the increase in gold’s price, which is far from being over due to the following reasons. One, the uncertainty surrounding the world economy fuelled investors’ appetite to speculate and drive the price to unprecedented levels, while providing an opportunity to offload gold holdings by investors, governments and others who have purchased it a while ago.

This will only be clearer when the dust settles and there is a final net tally for each country and investor’s gold holdings.

In a nutshell, the increase in the price in the first two stages was driven mainly by central banks and investors keen on diversifying their asset holdings, while the current stage is being driven by speculation and a way out of an investment that does not generate pay-outs similar to stock dividends and bond yields.

Two, and according to the World Gold Council, the most recent spike in price was accompanied a surge in investments into gold-backed Exchange Traded Funds (ETFs). For investors who find physical gold too expensive to buy, ETFs provide a cheaper way to diversify into gold, subject to timing of entry into the investment. Higher investments in ETFs require larger holdings of physical gold by those ETFs to retain whatever gold-to-shares ratio that they are expected to maintain.

A ‘cheaper’ option

Finally, it must be noted that the increase in the price did not result from a lack of other investment options. Actually, the spread of COVID-19 unearthed and provided bargains in financial markets and elsewhere, which would have been too expensive to get into a few years earlier. This allowed for new investments to be channelled into such options, and for existing investors to lower their average purchase price.

To conclude, the surge in gold’s price took almost two years to turn into an all-time high in recent history. The surge can be divided into three different stages to identify the factors driving it.

In the first two stages, the increase resulted from preliminary interest in securing gold holdings during uncertain times. The latest increase, though, is being driven by speculation and the need for an exit strategy out of an investment that can only pay off in the form of capital gains. Because such an exit strategy can be best-timed during a buyers’ market, speculation in gold has fuelled further speculation.

The last thought that I want to leave you with: Is the price of gold headed for $3,000?