Last week saw the gold price jump to over US$2,000 per troy ounce. It is currently trading at US$2,030, just off its all-time-high. Gold’s previous all-time high was US$1,921, last seen in September 2011.
Historically, gold has generally risen during risk-off periods when investors rebalance their portfolios away from assets like equities, perceiving turbulent times ahead. However, over the last few months both gold and equities have risen together.
So, what’s driving the gold price higher?
As I see it, here are the key factors currently driving up the gold price:
Hedging inflation risk
Historically, gold has been an important hedge against inflation risk. It has held its value very well during periods of high inflation. But you might wonder where the inflation risk is today, considering central banks globally are struggling to raise inflation to their target levels.
However, I believe, there are enough investors in the market who think that there is a good chance that inflation might resemble the genie in the bottle – currently, central banks are working hard to wake the genie (inflation). But once it emerges, it might be extremely difficult to put it back in the bottle.
This same view is likely driving up the price of the cryptocurrencies like Bitcoin, which rose more than 20% during the last 2 weeks. The key investment driver for both gold and Bitcoin is that their supply is limited and grows at a much slower pace than fiat currency issued by central banks.
Chinese demand picking up
China is the largest consumer of gold in the world, having overtaken India over the last few years. And as the Chinese economy rebounds from the impact of COVID-19, its economic growth is driving up the demand for gold. With India also loosening its COVID-19 lockdown measures, the global demand for gold might increase further. For instance, as Chinese economy opened up during the second quarter of 2020, the investment demand for gold during that period almost doubled to 583 tonnes compared to the corresponding period in 2019.
While there is a strong likelihood that global demand will rise further, the supply side is not likely to keep pace with the growth in demand because of COVID-19 restrictions on mining businesses, especially in countries which are among the largest producers of gold. This is likely to drive the price of gold higher still from current levels.
As a rising tide lifts all boats, the liquidity that central banks are infusing in global economy is raising the prices of all kinds of assets including gold. And with central banks expected to keep the liquidity tap open till at least the end of 2021, we are looking at a continuing supply of liquidity supporting the gold price.
Gold as an institutional investment alternative
For a long time, investment wisdom argued that gold is not an investment alternative because it does not generate income like equities do through dividends (present and future), or bonds through their interest payments, or even property through rental income.
However, currently about US$16 trillion of debt is priced at negative yield. A negative yield means that instead of a bond investor receiving interest income on his investment, he or she is in fact, paying money over and above the principal value of the bond. Imagine investing $100 to receive $98 a few years down the line!
With that as a backdrop, gold not generating any income suddenly does not sound so bad. In fact, global central banks had been net buyers of gold since the global financial crisis till COVID-19 struck this year. Taking the cue from the central banks regarding the need for diversification away from US dollar-denominated assets, even if there is a minor shift in the institutional asset allocation towards gold, we might see a further rise in gold price.
How can you benefit from the rising gold price?
One way that retail investors can benefit from the gold price rise is by investing in gold exchange-traded funds (ETFs) like ETFS Physical Gold ETF (ASX: GOLD).
However, for investors with a slightly higher risk appetite, investing in ASX gold mining companies could be an excellent option. As the gold price rises, mining companies generally see their profits grow even faster, because while they can now command a higher price for the yellow metal, their costs to mine the gold itself remain the same.
There are a number of gold mining shares listed on the S&P/ASX 200 Index (ASX: XJO) that could provide the opportunity for investors to benefit from the rising gold price. These include Newcrest Mining Limited (ASX: NCM), Gold Road Resources Ltd (ASX: GOR), Saracen Mineral Holdings Limited (ASX: SAR), Northern Star Resources Ltd (ASX: NST), Evolution Mining Limited (ASX: EVN).
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Motley Fool contributor Arpan Ranka has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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