In the summer of 2020, while stock markets were recovering from a pandemic-driven slump, an old asset made its comeback with a roar. In August, the price of gold surpassed the threshold of $2,000 an ounce for the first time in history. Few people who had been following the market were shocked at the news. “If you asked me at the end of 2019, I would have been bearish on gold. But given COVID-19 and the fiscal stimulus put in place, this didn’t come as a surprise,” said Bernard Dahdah, senior commodities analyst at Natixis investment bank.

A bumper year
Unlike many financial products, the precious metal had a fine year. By the end of 2020, its price had increased by 25 percent, outperforming other major asset classes. Its ascent was temporarily halted by a drop in March, coinciding with the economic shock brought by lockdowns, but this was followed by a rally that led to the record-breaking peak. In autumn, its dollar-denominated price hovered between $1,800 and $1,900.

Gold is the world’s oldest safe asset, always thriving in times of uncertainty

Nobody doubts that the gold rush is a side effect of an unprecedented healthcare crisis, forcing governments to throw the financial manual away. Gold is the world’s oldest safe asset, always thriving in times of uncertainty. Historically, investors have reverted to it as a hedge against political and economic tumult, with its price jumping during wars, contested elections and economic crises. During the Great Recession, gold’s price trebled from early 2007 to 2011. The same scenario is now repeating itself.

Government responses to the pandemic played a major part. In the US, loose monetary policy, accompanied by unprecedented fiscal stimulus to blunt the economic consequences of lockdowns, weakened the dollar to its lowest levels against the euro over the last two years, increasing the price of the dollar-denominated precious metal. Arkadiusz Sieron´, an analyst at Sunshine Profits, a precious metals investment company, said: “Gold reacted in a very bullish way not to the pandemic – its price declined initially in tandem with other assets – but to monetary and fiscal responses to the coronavirus.” Investors were left with few options other than traditional safe assets; unlike the credit crunch of 2008, a flight to emerging markets was less appealing. Government bond yields in the US and Europe were also lacklustre, with the former entering negative territory in March 2020.

Gold goes into first place
In the long term, what makes gold shine so bright in the eyes of investors is what has become a semi-permanent feature of the global economy: low interest rates, occasionally falling below zero. “If rates are high, you lose money by holding gold because of storage and insurance costs. But right now with yields being negative, gold is cheaper than holding US treasuries,” Dahdah said. Normally, the precious metal is also disadvantaged against other assets due to lack of earnings such as interest payments. However, in an era of dwindling returns, it has emerged supreme. In financial markets, the pandemic kick-started a chain reaction, according to David Govett, veteran trader and head of Govett Precious Metals, a consultancy: “This was the trigger, which in turn created a sort of reverse snowball effect. The higher it went, the more it attracted ETF, investment fund and speculative money.”

Even before the pandemic, many analysts were predicting that gold prices would rise, as clouds were gathering over the global economy. In 2019, the global debt to GDP ratio surged to a staggering 322 percent according to the Institute of International Finance, with many developed economies on the brink of recession. Leveraged loans held by financial institutions and ‘zombie’ companies had reached stratospheric levels, pointing to devaluation of the dollar.

Quantitative easing, aggressive government bond issuance and loose monetary policy were all depleting the value of fiat currency – a boon for gold holders. Jan Nieuwenhuijs, a precious metals analyst and editor of the influential blog The Gold Observer, said: “Given the state of the global financial system I would have thought that gold’s price would be higher a few years ago from where it trades today. Due to monetary expansion in recent decades and the Ponzi scheme created by financial asset price inflation, gold is still undervalued relative to other financial assets.” Geopolitical tension has played a role too, according to Professor Arvind Sahay, Chairman of the India Gold Policy Centre at the Indian Institute of Management Ahmedabad: “Growing tension between China and US contributed to the increase in the price of gold.”

The party isn’t over yet
In the short term, analysts expect gold prices to stay at the highest levels seen in the last 50 years (see Fig 1). The Bank of America forecasts gold to surpass $3,000 in 2021, while some analysts see an upper limit of $10,000 if central banks keep devaluating currencies. As long as interest rates are suppressed, gold will remain king, Nieuwenhuijs said: “Major central banks will hold interest rates at or below zero, while trying to boost consumer price inflation above two percent to lower the debt burden. Deeply negative real interest rates will boost gold demand and drive the price higher. Gold’s price can get an extra boost if financial bubbles pop.” Even when the worst of the pandemic is over, few analysts expect interest rates to rise. Dahdah said: “The Fed and the ECB will not raise rates the moment we have a vaccine. Even if everyone gets vaccinated in 2021, some businesses have been so badly hit that we will need to have low rates for two to three years.”

However, other investors expect prices to drop sharply after a sense of normality is restored. Vaccines will be the game-changer that will redirect focus to other financial assets. In the follow-up to the financial crisis, gold prices collapsed from $1,920 in 2011 to nearly $1,200 in 2013, partly due to a temporary increase in interest rates. Govett said: “I am not sure that the pandemic will ever be over completely, but certainly with an effective vaccine developed, I would expect a definite reaction on the downside in gold.” A big question mark hovering over the market is the shape of US fiscal and monetary policy. The forthcoming Biden administration is expected to unleash aggressive fiscal stimulus, while the Fed has hinted at keeping interest rates low until the US reaches full employment and inflation hits two percent. This would be a boon for gold prices, said Sieron´: “The bull market should last as long as the US monetary policy remains ultra dovish, or as long as investors expect it to be.”

Asia on hold
Skyrocketing gold prices have hit the market where the precious metal’s shine is appreciated the most: Asia. Historically, more than half of global gold purchases come from China and India, with countries such as Thailand, Indonesia and Turkey also being top markets.

Data held by the World Gold Council (WGC), the market development organisation for the gold industry, shows that around three out of four Chinese have bought gold in the past or are considering doing so in the future, while more than half of Indian investors own some form of the metal.

However, demand has sharply fallen this year. Global demand fell to its lowest levels since 2009 in the third quarter of 2020 according to WGC data, partly driven by dwindling demand in Asia. The pandemic has forced traditional buyers to postpone purchases and investors to ditch holdings, while lockdowns have hit the jewellery market. China and India have seen a drop in demand by 25 percent and 48 percent respectively in the first three quarters of 2020.

In 2013, falling prices prompted a surge of demand in China that has left its mark on the market, according to Roland Wang, Head of WGC’s China branch: “The gold rush exhausted demand for the following years, especially after the price fell from the peak. China’s economic growth slowed and China entered the ‘New Normal’ phase.” Another reason for dropping demand, according to Wang, is changes in consumer tastes, with younger consumers preferring lighter-weighted 24k hard gold products with trendy designs. “While they provided attractive margins to jewellers as they are per-piece priced, their popularity contributed to a reduction in total weights,” he said.

Government initiatives
The picture is similar in India, where gold is a highly valued status symbol offered at weddings and other festivities. Most of them have been postponed amid an economic crisis that cost around a tenth of Indian workers their jobs, while 45 percent of households saw their income drop. Over the last five years, annual demand has been falling by close to 20 percent compared to the first half of the decade, largely due to high prices and government initiatives to monetise gold.

The precious metal has become a political tool used to defy the dollar’s dominance as a reserve currency

However, the country is still the world’s biggest gold stock owner, with 25,000 tonnes, or 13 percent of global stock, owned by households and temples, according to UBS. “It is a highly unlikely scenario that Indians will fall out of love with gold. Millennials may be less interested in jewellery, preferring instead to hold it as an investment. But jewellers are working hard to keep them interested by selling them gold jewellery of a lower price range, so that they get into the habit of buying gold,” said Sahay.

Experts expect demand to rise again when the pandemic is over. In autumn 2020, many jewellery chains were reporting sales getting back to pre-pandemic levels, while a good monsoon season is expected to boost demand in rural India. Growing demand in Asia will stabilise the world market, Dahdah said: “In 2021 we will probably see a return to more normal levels of gold purchases from China and India, which might put a floor under gold prices.”

Central banks hoarding gold
Central banks have played a major role in the resurgence of the precious metal. Following the demise of the gold-backed Bretton Woods system in 1971, central banks fell out of love with gold, dumping their reserves in the last quarter of the 20th century. The UK famously sold half of its reserves between 1999 and 2002 when prices were hovering between $250 and $270. The policy cost British taxpayers an estimated almost £7bn, and earned Gordon Brown, then Chancellor of the Exchequer, the unwanted accolade of being responsible for the notorious ‘Brown Bottom’ sell-out. When gold’s price dropped to an all-time low in 1999 and its role as a reserve asset was threatened, central banks reached the Central Bank Gold Agreement (CBGA) to limit sales.

One reason why the world’s oldest store of value is making a comeback is its scarcity amid a boom of financial products

The tables turned after the financial crisis when central banks returned to the market with a vengeance. Since 2011 they have been buying gold aggressively to beef up their reserves. In 2018, central banks bought 651 tonnes of gold worth nearly $30bn according to World Gold Council data, a half-century record, while European central banks ditched the CBGA agreement in 2019 (see Fig 2). “The bear market that started a few years after the Great Recession lowered gold prices, making gold an attractive addition to central banks’ portfolio,” Sieron´ said.

The precious metal has become a political tool used to defy the dollar’s dominance as a reserve currency. Russia and China have increased their gold reserves three and six times respectively since 2007, while Turkey has boosted its own reserves by 500 percent since 2017 in an attempt to support its plunging currency. For emerging economies, the geopolitical angle is important, Dahdah said: “Since the financial crisis they realised that gold is a great hedge to diversify away from the dollar whenever there is uncertainty about the US economy. For political reasons we saw China and Russia selling dollar holdings and buying gold.”

However, many analysts expect the trend to subside due to a combination of high prices and the need for liquidity that can facilitate imports of dollar-denominated goods. Dahdah said: “Because of COVID-19, you won’t see them buying gold. They have other fires to fight. It would be a luxury and it’s expensive.” October 2020 was the first month during the last decade that central banks were net sellers, although sales were driven from two countries, Uzbekistan and Turkey. “Sales by Turkey, Uzbekistan, Tajikistan, Philippines, Mongolia and Russia in the last quarter of 2020 only reinforce its liquidity feature at a time of stress for these countries,” said Sudheesh Nambiath, Head of the India Gold Policy Centre.

Growing market for gold ETFs
One class of assets that has benefited from skyrocketing gold prices is gold exchange-traded funds (ETFs), which invest in the precious metal as their principal holding. Although a smallish market, they are seen as an oasis of serenity in the midst of a storm. They surpassed the threshold of 1,000 tonnes of new demand in 2020, while global holdings of gold ETFs hit a record of 3,880 tonnes in the third quarter of the year.

Gold ETFs are a relatively new financial instrument, with the first one appearing in India in 2007. On the back of growing investor interest, they now make up around a third of global gold demand. SPDR Gold Shares, one of the top holders of gold, briefly became the largest ETF in the world a decade ago. In India, their appeal is linked to their legal status, Nambiath said: “ETFs and sovereign gold bonds are the only two investment products that are regulated. This gives a lot more comfort to private investors.”

The picture is similar in China, which as a major gold producer favours the launch of gold-backed funds. Rising gold prices gave a new lease of life to the market; more than half of the gold ETFs listed in China were issued in 2020. Roland Wang from World Gold Council said: “Gold ETFs in China are backed at least 90 percent by physical gold at the Shanghai Gold Exchange, and investors in China view them as a form of physical gold investment.” Geopolitical pressures have played a role too: “Having witnessed volatile stock markets, rising tensions between China and the US, the trade war and the pandemic’s impact on the economy, Chinese investors are increasing their allocation of gold through convenient gold ETFs.” Payment services such as Alipay and WeChat also make them accessible to many retail investors, allowing them to buy fractional amounts worth as low as one yuan, according to Wang: “You can convert your gold ETF shares into physical bars, coins and jewellery easily, just one tap away from your phone on Alipay or other online platforms.”

In the developed world, gold ETFs are becoming the go-to option for many investors, Nieuwenhuijs said: “A lot of the money poured into gold ETFs in 2020 was institutional money that normally traded on the COMEX (gold futures). However, due to the dislocation in the gold market since March 2020, rolling long futures positions became very expensive and some funds moved their positions to ETFs.”

North America and Europe-listed ETFs accounted for 90 percent of global inflows in the third quarter of 2020, driven by low interest rates and uncertainty over government responses to COVID-19. “Usually gold bull markets are driven by demand in the west, and ETFs are one vehicle Western investors use to invest in gold,” said Nieuwenhuijs.

Some analysts question the prospects of the market, notably issuers’ ability to back claims with physical gold. Unlike bars and coins, ETFs come with counterparty risk and are linked with the financial system through ‘custodian’ banks that source and store gold for them. Though growing, it’s a market doomed to remain small, Govett said: “ETFs on the whole are used by investors who find holding physical gold either too expensive or too complicated. These ETFs need to be backed by physical and gold is a much, much smaller market than any other major investment tool, so it doesn’t take a lot to move the underlying price higher.”

A new golden era
One reason why the world’s oldest store of value is making a comeback is its scarcity amid a boom of financial products. Currently, it represents less than 0.5 percent of global financial assets, down from three percent 40 years ago, while its share of international reserves has fallen to 13 percent from close to 50 percent 20 years ago. It may become even scarcer amid worries over the carbon footprint of the gold-mining industry.

For some analysts, gold’s second coming is raising questions over the post-COVID-19 future of the global economy. In an era of low inflation, aggressive money printing and negative real interests, fiat money is losing its appeal, whereas governments cannot print gold. Many interpret central banks’ gold-buying spree as a sign of diminishing trust in legal tender. Increasing geopolitical tension may also boost its importance.

There have been rumours of China launching a gold-backed cryptocurrency, while Germany has been repatriating its gold reserves from the US, possibly as a response to souring relations with several US administrations. In a volatile financial system where gold remains one of the few stable assets, the precious metal may serve once again as an idiosyncratic kingmaker, according to Nieuwenhuijs: “As they say, whoever has the gold makes the rules.”