Gold’s in a bear market – What to do now

A cocktail of factors – from the rollout of the Covid vaccine across the world, to optimism about economic recovery to a spiking of US bond yields – has had a dampening effect on gold, pushing it into an official bear market. (A bear market is roughly defined by a 20% decline in any asset from its peak).

Global gold prices have tumbled from $2067 per troy ounce in August 2020 to $1676 per troy ounce by March 8 2021, a near 20% fall. Indian investors have experienced a slightly steeper fall (thanks to the 2% customs duty cut in the Budget), with prices declining from Rs 56,200 per 10 grams in August 2020 to Rs 44,150 by March 8 (down 22%).  

When any asset class is down and out, reports inevitably crop up predicting more gloom and doom for it. It has been no different for gold, with analysts, bloggers and sundry experts now predicting that this bear market for gold may stretch on for many years. We think that such doomsday predictions for gold are overdone. If you’ve been looking to add to the gold to your portfolio as a diversifier, now’s a good time to do it.

Here are our views countering the arguments circulating on the bearish outlook for gold.

#1 With the vaccine, the global recovery will gain ground, weakening gold

Its true that with multiple vaccines being rolled out and the vaccination drive progressing strongly around the world, there is likely to be an improvement in consumer confidence, paving the way for a recovery from the big Covid-related disruptions. According to IMF’s latest World Economic Outlook published in January 2021, world real GDP after shrinking 3.5% in the calendar year 2020 is expected to see 5.5% growth in 2021 and 4.2% growth in 2022. But arithmetically, this would mean that global output in 2021 is expected to be only at 2% above the depressed levels of 2020.

Advanced economies in particular are expected to see a very slow of recovery, with their 4.9% contraction in 2020 not expected to be made up by the 4.3% growth in 2021, with activity getting back to even keel only in 2022 (3.1% growth). Along the way, these economies will need to win over a second wave of infections and fatalities from Covid and the consequent battering to consumer confidence. This stretched out recovery process suggests that demand for safe haven assets like gold may not vanish overnight.

Should the recovery prove sharper-than-expected, there would be little justification for global central banks to continue with their QEs that have sent a tidal wave of cheap money flooding into financial assets ranging, from junk bonds to innovative start-ups. Any signs that these banks are withdrawing QE can trigger sharp sell-offs in both stocks and bonds. Such risk aversion will favour gold.  

# 2 Prices of commodities such as copper and crude oil have soared, suggesting a sharp economic recovery.  

Supply disruptions caused by global weather events and geopolitical tensions in Middle East, apart from improving demand have sent Brent Crude Oil prices soaring from below $20/barrel in April 2020 to nearly $70 now. Global copper prices, considered a lead indicator of industrial activity, have nearly doubled in the past year too.

Given the long bear market that has been on in commodities since 2011, many primary industrial materials and industrial metals have not seen significant capacity additions for nearly a decade now. Weather events this year have also fanned inflation in food prices with the FAO Food Price Index at 116, up 17% year on year. Therefore, it isn’t unlikely that we’ll see returning global inflation in the months ahead.

But this is not negative for gold, given its traditional role as a hedge against inflation. Traditionally, gold has held on its purchasing power far better than paper currencies, during inflationary scenarios. In fact, should inflation soar, and global central banks still continue with their stimulus efforts, that would be doubly positive for gold.  

# 3 But US treasury yields are rising, anticipating inflation. That’s negative for gold.

Yes, US government bonds are considered one of the safest assets to own globally. With yields on US treasuries up 40% in a month (Read our article on what you should do about the US yield spike),  there’s a good case for investors seeking a safe haven to move their money from risky assets into US treasuries. This is bad for gold. But remember, a rise in bond yields leads to capital losses for older investors holding bonds. Therefore, the yield spike is likely to make large institutions such as central sitting on stockpiles of US treasuries nervous.

A continued rise in yields can prompt them to exit older treasury holdings to avoid capital losses, even as they may buy into newer treasury issues. Don’t forget that the long-running QE has triggered one of the longest bull markets not just in stocks but also in global bonds. If US treasury yields continue to rise along with inflation, investors in bonds across the world would worry about capital losses and may sell off their older bond holdings. A simultaneous correction in both stocks and bonds can amplify gold’s safe haven appeal.      

Even if the US yield spike doesn’t go far, gold has historically shown a tendency to spike when real yields on US treasuries (the yield after accounting for inflation) fall. So if rising US yields don’t match inflation, that would be positive for gold prices.

# 4 The US dollar is strengthening. That’s bad for gold.

True, the US dollar tends to rise with US treasury yields and competes with gold as a safe haven asset. But when the dollar rises, this also makes gold imports costlier for economies like India which are large importers of gold.

For Indian gold investors, gold ETFs or gold funds also offer a good hedge against Rupee depreciation against the US dollar (about 3-4% of historical gold returns for Indian investors have come from the Rupee weakening against the dollar). Until recently, the Rupee held strong against the dollar. But should a global spike in yields prompt FPIs to pull out of Indian stocks or bonds, that could set off a bout of Rupee depreciation, bolstering Indian gold prices.  

# 5 Now that we have bitcoin, who needs gold!

One of the traditional reasons for investors to hold gold has been a mistrust of central banks and their tendency to consistently reduce the purchasing power of paper money by printing truckloads of it. Digital currencies like bitcoin have proved a good hedge against this. Bitcoin has certainly left gold in the dust during Covid times, as it is up 84% on a year-to-date basis and over 600% (under $8000 to over $54000) in the last one year.

While it is a favourite with start-up billionaires, technology investors and tech-savvy millennials, bitcoin attracts very few traditional investors as they seem to barely understand it. As digital currencies directly undermine their money-printing powers, central banks aren’t likely to be fans of bitcoins either and may prefer gold as a safe haven for diversification. 

As an individual investor, bitcoin (if you can identify its drivers) may offer you a shot at making quick money that isn’t correlated to the fortunes of other assets. But it isn’t a great asset to protect your capital or to hedge your portfolio against volatility in stocks or bonds, because it tends to be far more volatile than these assets. Gold in contrast suffers from very low daily volatility in price and tends to perform when other risky assets don’t. In a scenario of global risk aversion, gold may carry greater appeal as a safe-haven asset than bitcoin, owing to its lower volatility.

# 6 I think the Indian economy is going to show a V-shaped recovery. Then why buy gold and not stocks?

Gold definitely cannot replace stocks or even bonds in your portfolio. As we’ve shown in earlier articles gold is not a wealth creating asset in the long run. It offers no cash flows and delivers its returns in short bursts of action that feed on phases of uncertainty and fear in financial markets. This argues for a limited allocation to gold (of say 5-10%) in your portfolio to hedge against downside in equities or bonds.

If you don’t own any gold in your portfolio, price corrections like the current one present a good opportunity to build this allocation. If you own a low allocation and constantly worry about the stock markets correcting or bond prices tanking, this too is a good reason to hedge your bets with gold. We recommend buying gold ETFs or sovereign gold bonds from the secondary markets (subject to some caveats) to acquire your gold exposure now. Read more about these instruments here.