While everyone is watching the main US stock indices break records day after day thanks to FAMANG stocks, the gold price also keeps creeping higher towards $1800 per ounce. Many investors remain sceptical, as they struggle to value gold. But there’s a lot to say for the gold rally to continue.
Moreover, gold is the best performing major asset class over the past year (see graph). And over the past ten years, the compound return in euros has been around 11%. We know many institutional and private investors who would sign up for this.
The reasons for the outperformance of gold are obvious: the ongoing quantitative easing of central banks and macroeconomic uncertainty. We also see that uncertainty surrounding monetary policy tends to increase after recessions, and remains high for years. Social unrest, political volatility and rising international tensions will not disappear quickly. In such an environment, demand for defensive assets will remain high and increase further.
The similarities to the aftermath of the Great Financial Crisis are obvious. Back then, gold initially rose sharply as nominal interest rates fell and QE began in November 2008. Thereafter, the price of gold continued to move in a narrow range in the first half of 2009. That’s when QE began to have an impact. During this period there were short corrections, triggered by risk-on rotations from defensive assets, but in general gold did not have a pronounced direction for about six months.
The rally finally took off in October 2009, in line with a fall in real interest rates and an inflation pick-up triggered by easy monetary policy.
A similar path is very likely today. Real interest rates are being pushed down by a gradual normalisation of inflation expectations, while nominal interest rates remain low.
Valuation?
Many market observers remain sceptical, however. They follow the reasoning that gold “cannot be valued” as opposed to traditional financial assets such as equities and bonds, which can be included in all kinds of models. But that’s actually not true.
There are two common yardsticks for valuing the price of gold: the M2 money supply and the Dow-Gold ratio. There is a clear correlation between the annual growth rate of the M2 money supply and the price of gold. There is still a lot of catching up to do, and nothing points to a tighter policy over the coming years. On the contrary.
Second, there is the Dow-Gold ratio. It measures how many ounces of gold it takes to buy one unit in the Dow Jones Index. This indicator reached a low at the peak of the bull market at the end of the 1970s and is now going down again. The long-term trend is indeed downwards. There is a battle going on between financial assets (bonds and equities) and real assets. If macroeconomic conditions remain as they are now, there is a very good chance that gold will continue to perform in the coming years and that the stealth bull market will turn into a real bull market that could even be stronger than the technology bull market. In combination with the low allocations to gold in most (institutional) portfolios, this can cause the gold price to rally.
As the former CEO of Degroof Petercam Asset Management Jan Longeval said in a recent interview with Investment Officer: ‘Gold currently accounts for 12% of the reserves of the global central banks. Central banks love physical gold because, unlike dollars or euros, it has no counterparty risk. A dollar is in itself an IOU of the US Treasury. Gold is gold, there is no counterparty. It is a must in every portfolio and even more so, it will become one of the best performing investments in the coming decades. I do prefer physical gold. […].’
This suggests that the best years for gold are still ahead.