What's Driving Gold Prices So High, And What Might The Future Hold?
The price of gold hit an all-time high in early August, eclipsing $2,075 per troy ounce. Uncertainty surrounding the Covid-19 pandemic and the possibility of new government lockdowns is the driving force behind the high gold price. For centuries, investors have turned to gold as a safe haven store of value during times of downturn, volatility or crisis. The situation today is no different. However, some analysts predict that gold’s rally is far from over.
As the CEO and founder of an online alternative investment firm, I’ve helped countless retail and institutional customers invest in precious metals. (Full disclosure: I hold investments in physical gold and silver bullion.) In this article, I’ll touch on why gold’s recent surge isn’t a fluke and why some of the world’s top banks and financial institutions are forecasting a ceiling of $2,500 or more in the next 18 months, as well as the risks of investing in gold.
Gold Pricing 101: Inflation, Supply And Confidence
Several factors influence 24-hour gold prices. The first two influences, inflation and supply, are intrinsically tied. This is because gold has an inherently limited supply, which rarely undergoes significant changes from one year to the next. Therefore, gold is treated as an inflation hedge.
Gold prices are also influenced by fear and uncertainty in the market. In 2009, at the height of the Great Recession, the Producer Price Index (PPI) for gold rose 12.8%. Between 2008 and 2012, the PPI increased 101%, more than doubling in a span of only four years.
To fight the contractionary effects of a recession, central banks inject liquidity into the financial system. Inflation is a necessary side effect of pumping an economy with cash, which lowers the value of each dollar. Periods of monetary easing diminish investor confidence in the strength of the dollar and increase the demand for gold and silver, which are safe-haven alternatives to currencies and traditionally hold their value in weak economic environments. During the pandemic, investors have flocked to gold and silver bullion, gold stocks and exchange-traded funds to protect their wealth as trillions of dollars have flooded the U.S. economy in the form of quantitative easing and fiscal stimulus.
In April, Bank of America revised its initial 18-month gold price forecast from $2,000 (a number it originally eclipsed in July) to $3,000 per ounce. Analysts at the institution foresee long periods of inflation and sharp economic contractions combining to pump the value of gold and diminish the value of the U.S. dollar. It’s not gold supply and demand fundamentals that Bank of America sees pushing prices into uncharted territory, but financial repression. Financial repression occurs when a government borrows low-interest debt to restructure existing debts and finance government expenditures. The policy of financial repression, which has been studied since the 1970s, usually results in a commensurate increase in inflation, which causes an uptick in gold demand. Although nobody has a crystal ball to foresee the future price of an asset, signs currently point toward gold nearing or eclipsing the $2,500 resistance point sometime in 2020 or 2021.
The Downside Risk
All investing is subject to risk, and investing in precious metals is no different. The trick, of course, is to spread risk across a diversity of asset classes. Nonetheless, gold investing comes with opportunity costs and market risks like any other asset and is prone to speculative bubbles not unlike equities. Part of the downside of gold investing is that it offers no dividend and requires recurring capital payments to maintain it every year. This is why gold is often considered a “negative yield” asset. There’s an opportunity cost to investing in gold, because you could, alternatively, invest in dividend-paying stocks that reward you handsomely year after year.
The Bottom Line
Historically, gold has experienced an upward price movement amid broad uncertainty in the market. When economic conditions take a turn for the worse, gold prices generally rise. If the global economy continues to experience widespread disruption due to the novel coronavirus and supply chains and trade networks are severed due to geopolitical tensions, then we could see a gold price high that shatters previous records. Should the economy continue its downslide, gold could hit $2,500 or even $3,000 per ounce, as some experts predict. It’s 2020, after all, and anything can happen.