It came almost out of nowhere, a black swan event that engulfed the world. As everyone from citizens to governments scrambled to deal with Covid-19, the gold industry was impacted in unprecedented ways as well.
Our ITV report begins by highlighting the historic impacts the gold industry saw over the past three months:
· Price Action
· Liquidity Pressures
· Soaring Demand
· Supply Shortages
· Unlimited Fed Liquidity
· Inflation Prospects
· Historic Gold/Silver Ratio
Last quarter taught us a lot about our favorite investment. As you’ll see, the word “unprecedented” is not too strong to describe what transpired…
While the coronavirus began spreading in China in December, it did not make many headlines in North America until early January. The gold price initially rose as the fears gained traction, climbing roughly $150, nearly 10%, from its January low to February high.
But as the rout in equity markets picked up steam, gold succumbed to the pressure. The price fell nearly $200 from late February to early March, an 11.8% drop in three short weeks.
By the end of the quarter, though, despite the volatility and equity selloff, gold did its job: the price ended higher than where it started, hedging losses elsewhere.
Amidst a sea of losses, gold was up 5.6% last quarter. I’ll point out that the gold price has now risen six consecutive quarters.
In contrast, all major stock indexes were lower. In fact, the Dow booked its worst Q1 in 124 years. Oil was pummeled, partly due to the oil war between Russia and Saudi Arabia. Bitcoin fell 17%.
Even other precious metals prices struggled under the weight of Covid-19. Platinum registered its worst quarter since 2008, and silver logged its worst quarter since 2013. Palladium continued higher on the back of a supply crunch, though a slowing economy could weigh on demand given its industrial focus.
The 10-year Treasury outperformed gold, and while the US dollar rose, it lagged the gold price.
The value proposition offered by gold, as well as its hedging nature, was clearly evident last quarter. In fact, investors who owned gold entering the worst black swan event in modern history are sitting on gains.
Some investors questioned why the price of mankind’s oldest crisis hedge declined in the middle of a global pandemic.
In short, the rout in equity markets forced margin calls and immediate liquidity needs. Cash was desperately needed to meet unexpected and sudden margin requirements and offset losses elsewhere. To a large extent, gold was sold to meet those needs.
Meanwhile, many gold positions were sitting on a profit, with the metal up 18.8% last year and up 10% in early 2020 trading. Profits were ripe for the taking.
A similar effect was seen in October 2008. The sudden crash in equity markets pressured investors and traders to sell gold to meet margin demands.
This fact highlights another advantage of the yellow metal: gold can be a very useful tool when liquidity needs arise.
That gold demand spiked last quarter is an understatement. That spike was so sudden and strong that it overwhelmed the industry. Here are some highlights:
· Retail demand for physical product was, by any account, greater than what was seen during Y2K, 9/11, or the Great Financial Crisis. Volumes were reported to be 5-10x higher. Many trading desks shut down. Many products were backordered 3+ months. Premiums rocketed higher.
- Institutional demand soared, particularly after Goldman Sachs released a report saying gold was at an inflection point and it was time to buy on the back of the new Fed stimulus measures.
· Comex inventories were tested. In response, the exchange recently moved 34 tonnes, about 13% of total holdings, from the “eligible” to “registered” category, to increase the amount of deliverable ounces.
· Gold contracts in NY traded at a $60 premium to those in London, the highest spread since 1980. Several news reports said this development “rattled even veteran traders.”
Overall, demand ranged from an incredible two to as much as five standard deviations above normal. That surge led to…
In a relatively short period of time, the availability of physical metal was in short supply.
Not only did the spike in demand gobble up more supply than usual, the virus hindered the industry’s ability to supply metal. It is not far-fetched to say that the entire supply chain was disrupted, something many insiders thought would never occur.
· The US and Royal Canadian Mints both shut down. A West Point Mint police officer recently tested positive for Covid-19.
· Many gold refineries around the world were shuttered. Three refineries in Switzerland, a global hub for precious metals refining, suspended operations, which took offline 1,500 tonnes of gold annually between the three of them. The huge Rand Refinery in South Africa is operating at reduced capacity.
· With most flights canceled it has become more challenging to transport metal, as well as more expensive. One airplane can only take so much gold; the value becomes an issue since insurance will only cover a certain amount.
· Mining operations have also been disrupted. Several countries announced nation-wide shutdowns, including South Africa, one of the globe’s biggest sources of new metal. Operations were also suspended elsewhere, from Chile and Peru to Argentina and Canada.
· Other miners and refiners stopped deliveries that had not formally announced it. Some countries like China and Indonesia have not publicly reported, though news sources have cited various mine shutdowns.
The disruption to the industry has affected every part of the supply chain. Future supply is also impacted, as miners generally cannot restart operations overnight.
Unlimited Fed Liquidity
The response to Covid-19 by central bankers and governments has been swift and dramatic. The net effect of these actions are very supportive to the gold price.
Over 50 countries cut rates last quarter, including the Eurozone, UK, Japan, Canada, and Switzerland, among others. The US Fed cut rates twice—the first unscheduled action since 2008—bringing rates to near zero.
Further, global liquidity injections were decisive and on a scale never before seen. The details have fluctuated, but the latest includes the Fed planning to inject $4 trillion of liquidity through business loans, while the US government agreed to a $2.2 trillion stimulus package… Germany enacted a loan program that could provide up to €550 billion (US$610 billion) in corporate loans… the Bank of Japan significantly increased spending on ETFs and corporate bonds, while the government issued two loan packages totaling nearly US$20 billion… the European Central Bank said it may remove the limits on its Pandemic Emergency Purchase Program, currently €750 billion (US$821 billion)… and Italy unveiled a €25 billion (US$28 billion) stimulus plan, split into two packages of loans to small- and medium-sized companies.
The amount of planned worldwide stimulus is without precedent. Any reasonable conclusion must acknowledge the need to own gold, as well as the probability of higher prices, potentially much higher.
Recent policy decisions by the Fed and most central banks are likely to have long-lasting ramifications on the global economy. These decisions underscore the investment case for gold, as well as the likelihood of demand remaining high for the foreseeable future.
The US deficit, already high, will grow even further. The same is true in developed economies. Currency debasement concerns will easily equal or exceed what was seen in the Global Financial Crisis. The concern this time is that it could lead to actual inflation, not just the fear of it.
It seems only prudent to hold an appropriate weighting to gold to offset potential inflationary outcomes from central bank actions.
Historic Gold/Silver Ratio
The gold/silver ratio (gold price divided by the silver price) made history last quarter. Its prior record high was 100.8 in 1991—but it hit 123.4 on March 17.
The ratio remains at extreme level, ending the quarter at 112.4.
The value offered by silver, relative to gold, is hard to overstate.
The Gold Advantage
We said last quarter that “the number of risks embedded in global economies, markets, and currencies point to the increased likelihood of a major crisis.” Little did we know.
What we do know is that gold performed as expected. And that that performance is almost certainly far from over—indeed, it is likely just getting started.
The advantages of holding physical gold were made abundantly clear last quarter. I encourage all to make sure they have meaningful exposure, as we face the ongoing challenges of a global pandemic and the subsequent economic and monetary fallout.
To view the complete free SWP Q2 newsletter, visit: https://swpcayman.info/newsletterQ2