The price of gold has risen strongly in 2020, with the precious metal reaching all-time highs above USD 2,000 and AUD 2,800 per troy ounce in August of this year. The price has since corrected by approximately 10% in both currencies, finishing September trading at USD 1,886 and AUD 2,654 per troy ounce.
Year-to-date, the gold price has risen by almost 25% in both USD and AUD terms. In doing so, it has not only strongly outperformed traditional investment markets, but also provided much needed portfolio diversification for investors.
What has driven the gold rally?
There have been multiple factors driving gold, many of which date back to 4Q18, when the gold price was trading below USD 1,200 per troy ounce.
The most important contributor has been the decline in real yields on fixed income securities like government bonds.
As an example, the yield on a US 10-year Treasury Bond has fallen by more than 2% in the past two years, from +1.08% in October 2018 to 0.94% at the end of September 2020. Declining real yields reduce the opportunity cost of investing in gold, typically making the precious metal more attractive to investors.
The chart below demonstrates this by showing the movement in the USD gold price and movements in the real-yield on the US 10-year Treasury Bond from 2003 to end September 2020.
The chart makes it clear that the lower real yields go, the better the gold price tends to perform.
The importance of real yields is equally important for Australian investors. A study by The Perth Mint using Australian market data from 1971 to 2019 found that the price of gold delivered average gains of more than 20% per annum in years where real interest rates were 2% or lower.
The second factor driving the gold price is heightened equity market volatility. While the COVID-19 induced sell-off in equities is fresh in investors’ minds, there was also an equity market correction of more than 10% in 4Q18. This helped reignite interest in gold as a portfolio hedge, with the precious metal up by 58% in USD terms and 61% in AUD terms since then.
Investors turning to gold as an equity market hedge is a historical norm, with research highlighting the precious metal has typically been the highest performing single asset class in the months, quarters and years where equities decline in value.
Potential headwinds for gold
There are multiple risk factors that could pose headwinds to the gold price in the years ahead. These include:
- A significant rise in the USD. Gold typically performs very well when the USD is weakening, with performance more subdued (though not necessarily negative) during periods of USD strength.
- A strong pick-up in economic growth. A faster than expected V-shaped recovery from the decline in economic output caused by COVID-19 could be negative for gold.
- An earnings-driven bull market in equities. If equity prices are driven higher by a recovery in earnings, rather than cheap money, then the desire by investors to own gold as a risk-hedge may dissipate.
- Declining inflation expectations. A decrease in inflation expectations could be a headwind for gold as it would increase the real yield on financial assets.
While gold could still prosper in an environment where one or even two of these factors came to fruition, it would most likely struggle if they all came into play.
The outlook for gold
While the above risks need to be monitored, the chances of them all happening are remote. Most economic commentators are now expecting a K-shaped economic recovery at best, where some sectors recover sharply whilst others stagnate for years.
The International Monetary Fund (IMF) table below highlights expected growth rates in 2020 and 2021. It suggests that total economic output from advanced economies will be smaller by the end of next year relative to where it was pre-COVID-19.
This subdued economic environment can be expected to constrain sales-driven company earnings outside of a few select companies and sectors. This poses a significant challenge for equity markets given many are trading at historically elevated multiples.
Monetary policy is also likely to be dovish for many years, with The US Federal Reserve for example now adopting an average inflation rate targeting regime. Combine this with expansionary fiscal policy and one suspects there is more risk that inflation will surprise to the upside relative to the downside in years to come.
Gold should be well supported even if inflation rates and bond yields remain at or near the historic lows they currently sit. Analysis by the World Gold Council highlights that the average real return on gold has been 3.58% in years where inflation was below 3%.
That might not sound like a lot, but it is still substantially higher than the negative real rates SMSF trustees are earning in cash and term deposits. It is also higher than the current real yield an investor would earn on US Treasury Bonds of all maturities as highlighted in the table below.
Going forward, if gold matches its historical returns in low inflation environments, it is set to outperform US Treasury Bonds by somewhere between 3.9% and 4.8% per annum.
Given the above factors it seems likely there will be ongoing demand for precious metals, with the potential for gold to complement cash and bonds as a defensive asset enhanced by the monetary environment investors must navigate today.
For these reasons, we remain constructive on the outlook for the gold price, which we believe will remain biased to the upside for some time to come.
How to invest in gold?
Whilst some investors prefer to get gold price exposure via gold mining companies, these are a very distinct investment from the precious metal itself. They also tend to be substantially more volatile.
This is unsurprising given gold mining companies are exposed to a range of risk factors, from production costs, to reserve levels, to jurisdictional risk, to gearing and balance sheet strength, all of which can impact their performance, over and above the movements in the gold price itself.
For those who want to invest directly in gold there are many ways to invest. The three main options are as follows:
- Buy physical bars and coins to store privately.
- Invest via a depository account where the metal stays with a custodian.
- Invest in a gold ETF
The Perth Mint, which offers all these solutions to investors, has seen strong growth across all three offerings in 2020. The standout has been the growth of our ASX listed product, Perth Mint Gold (ASX: PMGOLD), which tracks the price of gold in Australian dollars.
Total investments in PMGOLD have increased by more than 70% in 2020, with this growth being led by self-directed investors including SMSF trustees, many of whom are allocating to precious metals for the first time.
The growth of PMGOLD reflects a global theme, with calendar year inflows into gold ETFs around the world hitting 980 tonnes by mid-September 2020. As you can see in the chart below, the inflows seen in the first nine months of this year far exceed those seen in any full calendar year.
This is strong evidence highlighting the sustained demand for precious metals in investor portfolios.
Despite the scale of these inflows, the best estimates suggest that portfolio allocations to gold are still less than 1% of total investable assets worldwide. If history is any guide, gold is far from over-owned in investor portfolios.
Why The Perth Mint?
Investors, from SMSF trustees to financial advisers and APRA regulated superannuation funds are increasingly turning to The Perth Mint for their precious metal investments.
Key reasons for this include:
Ownership and heritage
Wholly owned by the Government of Western Australia, The Perth Mint was founded in 1899 and has been operating continuously for more than 120 years.
Range of investment solutions
The Perth Mint is the only institution in Australia that offers physical gold bars and coins, direct depository solutions, a digital savings app and an exchange-traded fund. Our suite of products are designed to suit all investors irrespective of their budget.
Australian gold
Australia has been the second largest gold miner in the world for the past 10 years, with annual production now in excess of 320 tonnes – worth more than AUD 25 billion per year. The Perth Mint refines the vast majority of this gold, servicing a gold mining community that supports the livelihoods of more than 200,000 Australians.
When investors buy a Perth Mint gold bar, gold coin, gold ETF or uses a Perth Mint depository account, they are investing in gold that has been predominantly mined, refined, fabricated and vaulted in Australia.
Precious metal expertise
The Perth Mint runs one of the largest integrated precious metals businesses in the world, from refining and minting to treasury and depository services. With annual turnover of more than AUD 23 billion, The Perth Mint custodies over AUD 5.5 billion in client metal on behalf of more than 60,000 clients located around the globe. The organisation also exports physical bars and coins to more than 130 countries annually.
Globally accredited
The Perth Mint is one of the few refiners of precious metals accredited by all five major global precious metals exchanges, including the London Bullion Market Association and New York Commodity Exchange.
Unmatched security
The Perth Mint operates the largest network of central bank grade vaults in the Southern Hemisphere. Investors are also protected by the unique government guarantee that underpins our liabilities to depositors, which is enshrined in WA legislation.
All of these factors contribute to security and comfort that investors have when allocating to precious metals through The Perth Mint, with the organisation uniquely positioned to service Australian clients wanting to invest in this asset class.
Jordan Eliseo
Manager – Listed Products and Investment Research
The Perth Mint
We recently ran a webinar with Jordan – members can watch it here. Not a member? Sign up here and get access to all past webinars.