Gold is the only major commodity to post year-to-date gains in the first half of 2020. The COVID-19 crisis has ripped apart the playbook for 2020. The International Monetary Fund, for example, started the year off expecting 3.3% GDP growth. That has been revised down to -4.9%.
Cyclical assets experienced sharp drawdowns while defensive assets such as gold and US Treasuries have prospered. However, in recent months cyclical assets have staged a comeback as if these markets are expecting a V-shaped economic recovery. Unfortunately, the hard-economic data does not support such a swift economic recovery. Could the risk-on rally be gold’s undoing? Or will gold continue to remain in favour?
Gold sentiment off its all-time highs
Judging by positioning in gold futures markets, sentiment towards gold has come off its all-time highs set in February 2020.
That may not tell the full story. Assets in gold exchange traded commodities are at an all-time high at 103 million ounces. Indeed, positioning in gold futures may have been lower than otherwise would have been expected due to market dislocations at COMEX, where the futures are traded. As these dislocations are easing, we may see futures positioning rise once again.
“We expect positioning in gold futures to rise for several other reasons,” says Nitesh Shah, Director of Research at ETF fund manager WisdomTree. “The disconnect from the equity markets and the economy could drive investors to seek defensive hedges. The sustainability of rising indebtedness will likely worry some investors. We are in a US Presidential election year. In the last election cycle, speculative positioning rose to what at the time was the highest level in the run-up to the election.”
Shah says spikes in COVID-19 cases could also drive more investors to defensive positions. He also thinks we are in a U-shaped economic recovery.
“Continued economic stimulus will be required to prop up the economy,” he explains. “That will continue to distort various asset markets and leave them vulnerable to sharp corrections. A continued easing bias by the Federal Reserve will keep downward pressure on the US Treasury yields.”
U-shaped economic recovery
WisdomTree believes that inflation in the U-shaped recovery will be higher than that assumed by consensus. That is largely because supply chains are broken and so input prices for many goods and services are rising. Furthermore, official measures of consumer price index (CPI) inflation may fail to accurately reflect inflation in this COVID-19 crisis.
Notably, the consumption basket that statistics are compiled on are based on 2019 consumption, but what people consume today has shifted greatly in this new environment.
“We factor this into what we believe is reflective of an inflation experience rather than what will be measured by official statistics,” Shah says. “We believe the US dollar will move back to the upper end of the trading range we have seen in the past three months. If there is haven demand for gold in this uncertain environment, there is likely to be haven demand for the US dollar as well. Our model indicates we could get to a gold price of $2070/oz at the end of the forecast horizon and we pierce the previous all-time high reached in May 2011 by the end of this year.”