I am bullish about gold – primarily because I believe in the three following factors:
- the continued growing prosperity of the people in large emerging nations like Indonesia, India and China – especially as those who emerge from below the poverty line will inevitably make their first steps in savings through gold;
- the path to a multi-polar, multi-currency world – one that is not solely determined by and dependent on the US dollar – will lead to a greater need for a safe haven asset that is trusted by governments and central banks and not controlled by anyone – gold; and
- China’s desire to be a key player in the multi-polar, multi-currency world where the RMB is effectively backed by gold as part of its reserve management policy. Back in 2015, I calculated that China would have to buy every ounce of gold produced for the next 10 years or so; or buy what the entire world’s central banks bought in 2015 for the next 40-odd years if we assume that she wanted to be positioned as a major power with about 30% of its reserves held in gold.
But I also accept that some people prefer to make 12-month trading decisions instead of 5-year investment decisions.
So I have set out what I believe are three short-term drivers that investors typically look out for when they are deciding whether they should buy gold or not.
Risk-on risk-off
Risk-on risk-off is a term used to describe how investment activity responds to and is driven by changes in investor risk tolerance.
This theory states that investors tend to buy higher-risk investments when they think that the risk in the overall economic environment is low. For example, when both inflation and interest rates are low or when the economy corporate earnings are expanding in line or above market expectations.
On the other hand, when risk in the economic environment is perceived to be high, investors will generally sell their riskier investments and buy lower-risk investments like cash, government bonds and gold. For example, in the aftermath of the great financial crisis of 2008, stock prices crashed and the gold price went up.
It’s “easy” to see the uptrend in a risk-on environment as the stock market will continue to rise and set new all-time highs – more and more investors jump in to buy stocks and other high-risk investments out of fear of missing out.
In the case of markets that affect the gold price – it is the US stock market; and not Bursa Malaysia! It is harder to spot the change when investor sentiment starts to change.
Conventional signs to look out for in the financial press are when the US bond prices start to move up and their yields start to move down (bond yields go down as bond prices go up); when the VIX (volatility index) starts to increase. A rising VIX indicates an increased need to protect against risk and volatility.
Gold hedging
Historically, miners have hedged their gold production to lock in the price of their output, usually by selling future production forward. Although this means that mining companies will lose out if prices rise, it also means that they are protected from falling gold prices.
So many analysts look at the movement in the amount of future gold production that is hedged to see how mining sentiment in respect of future gold prices changes over time.
An increase in hedging would suggest that miners are becoming bearish. Conversely, a reduction in hedging would mean that they are becoming bullish.
Inflation
Inflation is significantly higher than it has been for a long time and I believe it will stay high for longer than we would like.
After initially dominating headlines in the US, inflation is now a problem for many countries. The International Monetary Fund’s World Economic Outlook recently reported that 15 of the 34 countries classified as ‘advanced’ economies experienced 12-month inflation running above 5%. Such a sudden, shared jump in high inflation (by modern standards) has not been seen in more than 20 years.
And it isn’t just the advanced economies, 78 out of 109 emerging markets and developing economies are also confronting annual inflation rates above 5%. It looks like inflation has become a global problem.
And historically gold has done especially well in times of high inflation.
