Sometimes you have to join the herd

Why this gold rally is different and why we can talk openly about prices in excess of $2,000 per ounce without fear of being committed to an asylum.

I’m generally happier having a contrarian view to the masses but the evidence supporting higher gold prices is simply overwhelming at the moment.

This bull run is entering its third decade if you consider that the events of 1999 laid the groundwork for the start of the rally. 1999 will be remembered for two tragic events and two defining interventions which have led to the gold industry being worth literally trillions of dollars more today than was the case at the end of the last century.

The tragic events in my mind were the demise of Ashanti Gold mine as a result of a poorly executed hedging strategy which left the Ghanaian miner brutally exposed to the smallest of upside moves in gold. The second tragedy was in the way Gordon Brown executed the sale of more than 50% the United Kingdom’s gold reserve assets.

Anyway that is ancient history and the good to come out of this desperate era of gold’s history was the ECB Gold Agreement and the collaboration of the world’s leading gold miners to stop killing themselves with excessive hedge programs.

Bring the clocks forward to present day and we have a central bank community that no longer needs the ECB gold agreement because gold is no longer the pariah within a reserve asset portfolio and we have a robust landscape for the mining industry where the derivative market is being used sparingly and responsibly.

So, with the official sector showing a greater appreciation for gold as a reserve asset and the producer community demonstrating a more sustainable approach towards the mining of this precious resource, we have a bona fide store of value in gold which will play a role in the current environment.

There have been multiple occasions in the last 20 years where gold has provided a temporary safe-haven function for institutional investors, but often this had led to short term rallies, with macro managers keen to divest as soon as they feel that the financial markets are safe to reinvest into. The global financial crisis of 2008 is a good example of the financial markets going right to the very edge, but it didn’t go over the edge and after breaching $1900 briefly in September 2011, we saw a trend from all sectors of the investment community to move back into assets that provided yield or dividends during the years that followed. Central Banks on the other hand have seen the importance of holding gold and have continued to accumulate around 500 tons per annum since the crisis.

The other balancing element that analysts will rightly point to is the supply demand elasticity amongst the influential physical centres predominantly in emerging markets. A high USD gold price together with a strong dollar cause severe price spikes in local currencies, which will always dampen demand in the short term. This time around I believe gold’s role is better understood as a wealth preserver and if the US Dollar fails to outperform other international currencies as seems likely following the economic fallout from Covid 19, then perhaps the gold price action in local currencies won’t be as exaggerated as we’ve seen on previous occasions.

So, whilst these two self-adjusting concepts will still exist, there are more macro fund managers looking to enter the market than we have ever seen before because the economic backdrop has never been as precarious as it is now, so even if a more “normal” market returns, I think the investor community will continue to be net buyers.

As for the fundamental physical buyers, yes there will be a slowdown in demand at these higher prices but I believe it will be relatively short lived and if the USD is about to have a weakening trend, these local currency price spikes are not going to look so severe after all.
We have low interest rates for the foreseeable future and we have increasing distrust in the custodians of the FIAT currency systems and so the stars are pretty much aligned for this rally to keep running and potentially gathering pace as it moves higher.

The move from $1300 to $1500 was steady and controlled, whereas the move from $1600 to $1750 was less orderly. I could imagine $1750 to $1950 (surpassing the 2011 all time high) to be fraught with market dislocations and of course when we break the magic $2000 mark I could imagine a very volatile scenario where $50 gaps become the norm.

In the context of other markets, gold is still very much a functioning market and metal is available to be traded with physical delivery still a practical option. Will this still be the case if newcomers to the market put a greater emphasis on owning physical rather than paper gold which is clearly what is happening now.

In summary, market dislocations will always lead to increased volatility which will invariably lead to higher prices. It therefore seems inevitable that we are at the start of a vicious upward spiral for gold prices.

Matthew KeenSometimes you have to join the herd