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Has gold lost its glitter?

The current crisis has been an opportunity for gold to shine, and it has. However, many investors expected an even stronger performance. Our Global CIO Yves Bonzon explains why gold has behaved differently to the financial crisis of 2008.

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Gold prices topped out slightly above USD 1,900 per ounce in 2011 and subsequently went through a multi-year consolidation phase ranging between roughly USD 1200 and 1400 per ounce. The recent crisis was an opportunity for gold to shine again, and today it is one of the best performing asset classes.

Nevertheless, we get questions as to why gold has not performed even stronger in light of the amount of money that central banks are printing. In no time at all, we have seen the balance sheet of the Federal Reserve move from slightly less than four trillion to more than seven trillion, and it is on its way to nine or ten trillion in the not too distant future. 

A very special asset class
Gold is fundamentally misunderstood and we think this is an opportunity to revisit what really drives gold prices. First, let us contextualise. Gold is a rather small asset class accounting for about 1% of total financial assets, with a total value of roughly USD 1 to 1.3 trillion. 

Gold has unique fundamental characteristics: fundamentally, gold cannot be printed. Its supply is constrained, which makes it a store of value. However, the most precious characteristic of gold is the fact that it is the only financial asset which, when held in physical form, doesn’t represent a claim against someone else. When you buy a bond, you have a claim against the revenue of the firm that has issued the bond. When you buy an equity, you have a claim against the residual profit of that business. Therefore, there is a counterparty risk. If the counterparty does not pay the promised amount, your investment will be impaired.

A hedge against systemic risk
When systemic risk is rising, such as during the banking crisis in 2008, gold goes up strongly in value because it is one of the rare assets that doesn’t have counterparty risk characteristics. In other words, it is a hedge against systemic risk. If central banks print too much money and inflation eventually picks up, gold, to a certain extent, will also hedge you against that inflation risk because it will be revalued when priced in dollars, euros or whatever currency is your reference point.

What is happening today? The response from central banks to the crisis was so comprehensive, rapid and deep that systemic risk never really had a chance to wake up, and very quickly financial markets stabilised. The systemic risk angle to gold prices never kicked in, but that could obviously change. Governments are currently coming up with coordinated, diverse fiscal responses, and we have some concern about an increasingly heterogeneous economic recovery across countries. However, so far, the risk remains tilted in our view towards deflation. 

The recession is already priced in
We are not at the point where inflation is around the corner and the merits of gold as an inflation hedge would start to play out. Therefore, in the short run, we think that the recent gold price of USD 1700 has fully priced in the recession provoked by the containment measures against the virus. The economy is slowly starting to recover and, for now, we think most of the gains on the gold price are behind us. We expect a phase of consolidation and another leg up in the price of gold in the not too distant future.