What a difference a few years makes. Back in the summer of 2015, a WSJ op-ed writer, who somehow was unaware of the past 6,000 years of human history, infamously and embarrassingly said “Let’s Be Honest About Gold: It’s a Pet Rock.” Fast forward to today, when with every central bank once again rushing to debase its currency in what increasingly appears to be the final race to the debasement bottom, when even BOE head Mark Carney recommends that it is time to retire the dollar as the world’s reserve currency,
pet rock gold has emerged as the second best performing asset of the year… and at the rate it is going –4th in 2017, 3rd in 2018, 2nd in 2019 – gold will be the standout asset class of 2020.
Which naturally has sparked comparisons for gold’s performance in 2019 with 2008+, when gold exploded higher as the financial system nearly collapsed and central banks started injecting trillions in liquidity into the system to keep it afloat.
Are such comparisons appropriate?
As Bank of America writes in “anatomy of two gold bull markets”, in comparing the gold bull markets in 2008 and 2018, real rates remain key price drivers, while a critical difference in market dynamics – this time around – is that central banks have been unable to reflate global economies and even as metrics like the value and proportion of negative yielding assets has been increasing, further easing is on the cards. Linked to that, Bank of America makes a stunning admissions: “the risk of quantitative failure, which was not a concern in 2008, makes gold an attractive asset.”
BofA summarizes the key gold drivers in 2008+ and 2018+ across three key metrics: real interest rates, USD and volatility.
Taking a step back, for those who have not been following the performance of gold in the past year, the yellow metal has been one of the best performing commodities over the past year, rallying by 31% since bottoming in August 2018, as whon in the first chart which highlights that recent price dynamics have to some extent mirrored those seen in 2008+; the data also shows that the current bull market is still young. Partially because of that, Bank of America notes that it has been frequently been asked how the current macro backdrop compares to dynamics 10 years ago.
So what sparked the tremendous 2008 rally which lasted for the next three years?
Looking back at the Great Financial Crisis, central banks reacted to the turmoil on financial markets by easing monetary policy through both traditional, but increasingly also non-traditional policy tools
Since gold is a non-yielding asset, the reduction in opportunity costs and uncertainty over where the global economy and markets were headed made the commodity an interesting investment.
This is shown in Chart 4, which suggests that sharp declines in US real rates post GFC were accompanied by steady increases in gold quotations. Yet, US rates then started to change direction in 2013, the year Fed chairman Ben Bernanke caused the taper tantrum announcing that the Fed would gradually reduce its bond purchases (Chart 5). This effectively put an end to gold increases.
After the gold price rally ended, and fell sharply in the wake of the taper tantrum, gold prices then remained subdued also because ongoing monetary policy support kept markets buoyant. This is shown in chart 6, which highlights that falling volatility was ultimately accompanied by lower gold quotations. Of course, this was also influenced by an acceleration of the US economy, which picked up post GFC and in 2015 printed some of the highest growth rates in a decade
Unfortunately, the central banks’ fairy tale did not last, and the “strong economic growth” came with a significant wrinkle: inflation remained well below the 2% target. The chart shows data for the US, but the lack of upward pressure on general price levels has been equally pronounced in other countries/ regions including Japan/ Europe.
Yet notwithstanding the ongoing lack of reflation, central banks around the world seem adamant that monetary easing will ultimately do the job – as in it didn’t work last time, but it will work this time, we promise – and hence expectations are for more stimulus. The side-effects of that are mirrored by Chart 8 and Chart 9: value and proportion of debt with negative yields has risen almost exponentially of late and this has been a powerful driver of the gold.
This, according to BofA commodity strategists, has various implications. Most notably, “ultra-easy monetary policies have led to distortions across various asset classes”; worse – and these are not our words, but of Bank of America – “it also stopped normal economic adjustment/ renewal mechanisms by for instance sustaining economic participants that would normally have gone out of business”, i.e. a record number of zombie corporations.
In addition, as everyone knows, debt levels have continued to increase, making it more difficult for central banks to normalize monetary policy as 2018 showed so vividly (and for Powell, painfully).
Which brings us to BofA’s conclusion: “We fear that this dynamic could ultimately lead to “quantitative failure”, under which markets refocus on those elevated liabilities and the lack of global growth, which would in all likelihood lead to a material increase in volatility.”
How does gold fall into this: “At the same time, and perhaps perversely, such a sell-off may prompt central banks to ease more aggressively, making gold an even more attractive asset to hold.”
In other words, as the world approaches the financial endgame and central banks are out of ammo beside just doing more of the same – that led the world to the current catastrophic state – gold will be the biggest beneficiary of the upcoming financial cataclysm. And, no, this is not some fringe blog predicting the apocalypse, this is the prediction of one the 4 largest US banks.
And with that we hand it over to the WSJ’s Jason Zweig for his “Per Rock” sequel…