The coronavirus sell-off and subsequent rapid market rebound has seen US tech stocks soar to new highs and cyclical assets follow in close pursuit as economies re-open.
Yet as risk assets continue to rally into the third quarter of 2020, gold has also risen to its highest level in years, breaking the $1,800 per ounce mark.
The price of gold (as represented by the Bloomberg Gold Sub index) has risen by around 17 per cent year-to-date in US dollar terms, making it one of the few commodities to post a positive return the first half of 2020.
One of the reasons why gold is seen as an attractive defensive asset is due to the fact that it typically rallies when markets fall and risk is off, providing a hedge for portfolios.
On the flipside of that, when risk is back on and markets rally, it does not perform as well. So, when both gold and risk assets are rallying into the third quarter of 2020, the outlook for both becomes less clear.
Performance of index year-to-date
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Source: FE Analytics
Commodity strategists at Saxo Bank have argued that “the belief that we can and will return to normal within a few quarters will most likely turn out to be wrong”.
The Danish investment bank has a bullish outlook for gold and predicts that it will rise to at least $1,800 per ounce in 2020, followed by a fresh record-high in the coming years.
“Gold’s ability to frustrate, then eventually reward, the patient investor is likely to be on full display during the third quarter,” said Ole Hansen, head of commodity strategy at Saxo Bank.
In a note outlining its third quarter outlook, the strategist argued that the next period will see low to negative growth, rising levels of debt and eventually rising inflation.
“A pandemic which is far from over coupled with a potential second wave looming over the horizon threatens to derail the recent rallies witnessed in energy and industrials, and any additional growth in Q3 will be challenged,” he explained.
Given equity markets have bounced back strongly and the full economic impact of the Covid-19 crisis remains unclear, Evy Hambro, co-manager of the BlackRock World Mining Investment Trust and BlackRock Gold & General fund believes he will continue to see strong arguments for adding to gold and gold equities for diversification.
He said that the precious metal has proven its worth in a safe haven environment and that monetary policy globally is also likely to remain loose for a significant amount of time, which should support the gold price going forward.
“Over the medium term we have a coordinated central bank policy, firstly in terms of fixing the financial plumbing on the back of the current crisis, with the second phase being the high level of fiscal spending designed to get the global economy back up and running,” he explained.
He added that the US 10-year Treasury real rate of -0.73 per cent means the opportunity cost of holding gold has significantly reduced, and it is facing “a perfect environment” of supportive measures.
Hambro also shared his outlook for the demand and supply dynamics for gold, which play a crucial role in the yellow metal’s price.
“Mined gold production fell in 2019 for the first time in 11 years, which, in combination with increased industrial and speculative demand for gold, and decades of underinvestment, has put a floor under the recent rise in the gold price, which has now reached eight-year highs,” the BlackRock manager said.
“On the demand side, the impact of Covid-19 on global economies and the huge amount of fixed income assets with negative of near-zero yields, paints a very bullish picture for gold prices.”
He said some risks to the future upside in gold are a reduction in economic uncertainty, and the subsequent fall in demand for ‘safe haven’ assets, or the rise in real rates, which would increase the opportunity cost of holding gold.
Performance of BlackRock Gold & General YTD
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Source: FE Analytics
The BlackRock Gold & General fund, which invests predominantly in gold mining stocks, has returned 36.64 per cent year-to-date as gold mining companies have rallied on the back of rising gold prices.
Indeed, gold miners have demonstrated higher beta – indicating greater sensitivity– to metal prices in recent months.
Hambro said: “Gold equities were not immune to the liquidity drain in Q1 2020, however their performance since mid-March has been spectacular, as they returned to delivering beta of above one to moves in the gold price.
“We have seen continued improvements in the gold price, whilst costs have been relatively flat, which suggests a positive outlook for earnings growth – at a time when earnings will be significantly down for most other sectors.”
He added that the capital discipline of many gold mining companies remains intact, highlighting the large number of miners which have recently announced dividend increases.
With some forecasters expecting $2,000 per ounce for the price of gold, Hambro shared what the implications would be for gold mining stocks.
“At today’s price levels, gold companies are as profitable as the most profitable mining company, as well as some of the leading companies in other sectors,” he explained.
“As balance sheets and sentiment towards the gold space has been repaired over recent years, if costs remain stable, gold equities are likely to display a beta of above one to upward moves in the gold price.”
Rising dividends and future potential share price appreciation could be one of the reasons why certain UK equity income managers have also turned to gold mining companies for their funds.
Dan Hanbury, manager of ES R&M UK Equity Income fund, said: “Gold has set a record high in almost every currency in the world, including sterling, during this crisis already and only the US dollar record remains to be broken.
“The gold price is usually quite volatile and so investors should expect setbacks, but it is capable of surpassing $2,000 in this cycle as central banks buy debt in huge proportions, negative real rates persist and investors buy into this store of value.”
The manager revealed he currently has around 10 per cent of his small-cap and income funds invested in gold-related stocks.
While traditional dividend payers – such as GlaxoSmithKline, British American Tobacco, and Tesco – make up the equity income manager’s top holdings, gold miner Centamin also sits among its top-10 holdings, representing 2.3 per cent of the portfolio.
“The rally in the price of the precious metal is not fully reflected in the price of gold mining stocks, with their cost of extraction much lower than the current spot price and analyst models still lagging gold futures,” he added.