Gold’s Historic Function in the Aftermath of Extremes
What does all this mean in terms of the outlook for gold? In the last Gold Nuggets, my bullish case for gold suggested a possible trading range for 2020 of between $1,450 and $1,700. We have already seen those levels approached during intraday trading, and we have not even reached the close of the first quarter. But consider this: those parameters were set long before the World Health Organization declared the outbreak a public health emergency of international concern on January 30, before the world learned of the first death from the virus on January 9, and even before the Chinese government first alerted the WHO to a mystery virus on December 31 of last year. No one could possibly have predicted the outbreak of a global pandemic with all its attendant disruption. But history suggests that at some point, the stock market will find a level where it can stabilize, and we will see the end of investors selling gold to raise cash to protect their other investments. If the experiences of 2008, 2002 and 1987 are any guide, gold will rapidly recover its equilibrium, and the price will move on to higher ground.
Gold Supply/Demand: What Can We Expect?
How much higher can gold go? A useful starting point toward an answer lies with a consideration of the potential impact of COVID-19 on gold’s internal market dynamics and the balance between supply and demand. The coronavirus has clearly distorted supply chains all over the world, and it will be no different in the gold market. Over the past decade, the world’s gold refineries produced an average of 3,200 tonnes of gold a year.2 On March 23, three of the largest refineries in the world announced that they were suspending production entirely for at least a week because of the virus. The refineries are all located in the Swiss canton of Ticino, which borders on Italy, and together they process around 1,500 tonnes of gold a year. These shutdowns will have a significant impact on supply, especially if they are extended beyond one week and are accompanied by similar action on the part of other refineries.
Turning to the demand side, we expect jewelry demand in the first half of the year to fall because of the devastating impact the virus has had on China and India, the two largest consumers of gold jewelry in the world. At the same time, we expect some offset to that decline in the form of rising global investment demand, due in part to the appeal of gold as a perceived safe haven3 during black swan events.
Longer term, we believe investment will also strengthen in response to the actions being taken by central banks throughout the world in an attempt to combat the economic disruption caused by the coronavirus. For example, the Fed implemented Quantitative Easing (QE) in December 2008 to help stabilize financial markets and mitigate the impact of the Global Financial Crisis. The Fed continued with QE until October 2014, and during this period, its balance sheet ultimately increased from $900 billion to $4.5 trillion. Over the same period, the spot price of gold rose, on average, 8% per year.4 The Fed announced unlimited QE on March 23 this year. If history is any guide, gold prices are likely to move higher. But how much higher will depend on the size and duration of the Fed’s new round of QE and how it serves to mitigate global investor anxiety and market volatility.