Ray Dalio (Trades, Portfolio) has been bullish on gold for quite some time, and his bet on this precious metal is proving to be accurate. In two articles published last October and February on GuruFocus, I discussed a few possible reasons behind the guru’s investment thesis.
On July 6, gold prices surged above $1,800 per ounce – the first time this happened since 2011. During the historic rally more than nine years ago, the metal briefly traded above $1,900, and some analysts are confident that the current rally will help gold reach a high of over $2,000. Safe-haven assets are in high demand among retail and institutional investors, as there is a significant level of uncertainty regarding the outlook for the global economy in the short term.
Reasons behind the rise of gold prices
Multiple factors can determine the value of a commodity, and in the recent past, many of these forces have been favorable for gold.
First, the ultra-low interest rates in the United States are proving to be a tailwind driving gold prices higher. Since delivering an emergency rate cut in March, the Federal Reserve has confirmed its intention of keeping rates near zero in a bid to revive economic growth in the country. Traditional investments such as bonds and savings deposits, therefore, are increasingly becoming out of favor among risk-averse investors.
Gold has come to the rescue of many such investors, as investing in equity markets is considered riskier in comparison to the precious metal. In June, Fed Chair Jerome Powell hinted that policy rates are likely to remain close to zero at least until the end of 2021, which leaves ample time for gold prices to remain elevated.
Second, the U.S. dollar has shed some of its recent gains in the last three months, which is positive news for gold as the metal exhibits a negative relationship with the greenback. Since reaching a high in mid-March, the U.S. dollar index has declined by approximately 5%. This has boosted the appeal for gold among global investors, which has tilted the odds in favor of demand, leading to a surge in prices.
Source: Bloomberg
Third, the record inflows reported by gold-backed exchange-traded funds pushed the prices higher in the last three months. The World Gold Council, in its report on the performance of gold in the first half of this year, wrote:
“Gold-backed ETFs recorded their seventh consecutive month of positive flows, adding 104 tons in June – equivalent to $5.6 billion or 2.7% of assets under management – taking global holdings to new all-time highs of 3,612 tons. This brings H1 global net inflows to 734 tons, significantly above the highest level of annual inflows both in tonnage terms and U.S. dollar value.”
The below chart confirms that investors have never flocked to gold at the pace they have in the first six months this year.
Source: World Gold Council
The record inflow of funds ensures that the momentum is favorable for gold to continue to report gains as global economic powerhouses such as the United States, India, China and many European countries find it difficult to grow their economies at the desired pace.
The outlook remains strong
The factors discussed in the previous segment remain valid for the coming months as well. Therefore, I think it is reasonable to conclude that gold prices will continue to rise until there is clarity about the recovery of the global economy. The opportunity cost of investing in gold is very low as expected returns from fixed-interest investments are near zero. This would act as an incentive for prudent investors to divest bonds and reallocate funds more efficiently by investing in gold.
Analysts are bullish
Goldman Sachs analysts reiterated their $2,000 price target for gold on July 10 by citing a recovery scenario that is “ideal for gold” prices to move higher in the coming months. Many other renowned metal analysts are positive on the outlook for gold as well.
TD Securities head of global strategy Bart Melek told Kitco:
“Reopening might be not as quickly as people thought. Could see more closures in states like Florida and Texas. Plus, other countries could be more cautious when reopening based on the U.S. experience. We could see the economy suffer and see lousy numbers into August and September. For now, we might consolidate near the current levels. But the tilt is to the upside. The reason for that is that the economic recovery may be somewhat slower. The reality is that risk appetite might not move higher forever. And that realization will be solidified, and the Fed is going to end up doing more, not less. Gold will consolidate here and move higher.”
ABN Amro senior forex and precious metals strategist Georgette Boele said:
“Against the dollar, gold's all-time high of $1,921 is now within reach. The stars are aligned for gold prices to continue to rise. Aggressive monetary policy easing, ultra-low interest rates, negative U.S. real yields, fiscal stimulus, and the technical outlook all support gold prices.”
The macro-economic environment has never been this favorable for gold over the last five years as policymakers across the world were implementing contractionary monetary policies to curb inflation. Tables have turned and decision-makers are now forced to take bold measures to reignite economic growth, and such policies are keeping gold’s positive momentum intact.
Takeaway
Gold is up 19% this year as of July 13, and the rally has been supported by many favorable developments. Investing in this precious metal, however, is not only about capital appreciation. According to empirical evidence, exposure to gold will provide an acceptable degree of diversification benefits because of its negative correlation with interest rates and the strength of the U.S. dollar, and the near-zero correlation with equity markets. Even though prices have already risen substantially this year, gold should continue to be part of a portfolio as a hedge against a possible collapse in stock prices.
To add some perspective, the Buffett Indicator is still flashing warning signs at a ratio of above 150%, which is an early signal of an overvalued market. Tactically allocating assets to gold is likely to yield attractive returns in the coming months and provide downside protection in the worst-case scenario.
Disclosure: I do not own any stocks mentioned in this article.
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