SMM: in 2020, investors regard gold as an important portfolio hedging asset. Looking ahead, the market's expectation that the global economy will recover from the new crown epidemic is changing from a rapid rebound (V-shaped rebound) to a slow rebound (U-shaped rebound), and may even suffer multiple shocks (W-shaped rebound) as a result of repeated epidemics. Regardless of the pattern of economic recovery, the epidemic is likely to have a lasting impact on asset allocation. It will also continue to strengthen the role of gold as a strategic asset.
We believe that high risk, low opportunity cost and positive price potential will jointly support gold investment and offset weak demand on the consumer side of gold caused by economic contraction.
Although the stock market rebounded in the first half of the year, gold still reached a new high in nearly seven years.
Gold performed very well in the first half of 2020, with the price of gold in dollar terms rising 16.8 per cent, vastly outperforming all other major assets in the world over the same period.
As of the end of June, the price of gold in the afternoon of the, LBMA (London Bullion Market Association was nearing $1770 a troy ounce, the highest level since 2012, and gold prices in all other major currencies were also at or near record levels.
While global stock markets have rebounded sharply from their lows in the first quarter, the high degree of uncertainty and ultra-low interest rates caused by the new crown epidemic are still driving a strong flow of safe-haven money to safer, higher-quality assets. Like money market funds and premium bond funds, gold has benefited from safe-haven demand from investors, and its hedging role has been further highlighted by record inflows of gold ETF.
At the beginning of economic recovery, gold still has the advantage of risk aversion.
The new crown epidemic is having a devastating impact on the global economy. The International Monetary Fund (IMF) currently forecasts that global economic growth will contract by 4.9% in 2020, accompanied by high unemployment and shrinking social wealth.
There is a growing belief that the global economy will move from a rapid V-shaped rebound to a slow U-shaped rebound, or more likely that the recovery in the second half of the year will be short-lived, as repeated outbreaks will set the global economy back and lead to a W-shaped rebound.
For investors, this not only keeps uncertainty high, but may also have a long-term impact on the performance of their portfolios. In this context, we believe that gold can become a valuable asset: it can help investors spread risk and hopefully help improve risk-adjusted returns.
Under the impact of the new crown epidemic, the asset allocation strategy will be reshaped.
In response to the impact of the epidemic, central banks around the world have slashed interest rates and / or expanded their asset purchase programs in order to stabilize and stimulate their economies. However, these actions are having some unexpected impact on asset performance:
Stock market valuations soar, but this is not necessarily supported by fundamentals, thus increasing the possibility of a correction in the stock market.
Corporate bond prices are also rising, further depressing the credit quality curve;
The upside of short-term and high-quality bonds is limited, if any, so their hedging effect is reduced.
In addition, widespread fiscal stimulus and ballooning government debt are raising concerns about a long-term rise in inflation and a sharp devaluation of legal tender. However, some people believe that the more likely risk in the short term is deflation.
Given that these conditions exacerbate risks and may lead to lower-than-expected returns, we believe that gold will play an increasingly important role in investors' portfolios.
With the high valuation of the stock market, the risk aversion advantage of gold may be revealed.
For more than a decade, global stock markets have been in an upward trend almost unilaterally. The new crown epidemic broke the situation, causing the stock market to fall sharply, with all the world's major stock indexes falling more than 30% in the first quarter. Since then, however, the stock market has rebounded strongly, especially in technology stocks. But share prices do not seem to be fully supported by fundamentals or the overall state of the economy.
This is often referred to as the disagreement between Wall Street and ordinary people. In recent months, for example, the earnings ratio of the US stock market has jumped to its highest level since the bursting of the dotcom bubble.
Many investors are looking to profit from the current unilateral upward trend in the stock market, but there is also growing concern that the valuation bubble could lead to a sharp correction in the stock market, especially if the global economy is hit again by the second wave of the epidemic. Gold with hedging attributes will help to mitigate the risk caused by stock fluctuations.
The return on bonds may be limited, and gold is an effective substitute for it.
The low interest rate environment also encourages investors to buy long-term and shoddy bonds or simply swap bonds for riskier assets such as stocks and alternative investments to boost the risk level of their portfolios.
Looking ahead, we think it will be difficult for investors to get the same bond returns as they have in the past few decades. Our analysis shows that over the next 10 years, the average annual compound return on US Treasuries will be less than 2 per cent (fluctuating by 1 per cent).
Stagflation, moderating inflation, deflation?
While falling interest rates and asset purchase programmes are significantly affecting asset price valuations, it is unclear what impact expansionary monetary and fiscal policies will have on inflation.
Some argue that quantitative easing and rising debt levels themselves will trigger inflation and that consumer prices will spiral out of control sooner or later, even if economic growth remains sluggish (that is, stagflation). However, it has also been pointed out that past quantitative easing measures (not as aggressive as they are now) have not led to hyperinflation (at least not yet).
Another point of view refers to the experience of Japan and predicts that deflation may occur first. In fact, there are signs that this is already happening. In China, for example, the price of necessities soared during the quarantine, but the consumer price index (CPI) fell to 2.5 per cent in June from 5.2 per cent in February. Some economists expect full-blown deflation by the end of the year.
Historically, gold has protected investors from extreme inflation. In years when inflation was above 3 per cent, the price of gold rose by an average of 15 per cent. It is also worth noting that research by the Oxford Institute of Economics shows that gold should do well in a period of deflation. These periods are characterized by low interest rates and high financial pressures, both of which tend to push up demand for gold.
Weak consumer demand and continued boost in gold investment
Gold's performance is affected by four drivers:
Economic expansion: the period of economic growth is very conducive to the consumption of gold ornaments, the demand for gold for science and technology and the demand for long-term savings
Risk and uncertainty: market downturns tend to boost investment demand for gold as a safe haven
Opportunity cost: the prices of competitors, especially bonds (through interest rates) and currencies, as well as other assets, affect investors' attitudes towards gold
Potential energy: capital flows, positions and price trends can boost or restrain gold's performance.
In the current global economic environment, gold investment demand is supported by three of the four drivers, namely:
High risk and high uncertainty
Low opportunity cost
Positive price potential energy
But economic contraction may depress consumption of gold ornaments, demand for technology or long-term savings. This will be particularly evident in major gold markets such as China or India.
Historically, investment demand for gold in periods of high financial pressure can offset the negative impact of weak consumer demand, and we believe that 2020 will be no exception.
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