Market Update — Failed monetary policies lift gold

Analysts are scrambling to increase their gold price forecasts, as the gold price continues to rise. The gold price breached US$1,360/oz. for a second time in 2016, a level previously seen in early 2014. A weak Japanese bond auction on August 2nd unnerved markets, pushing the gold price up 29% for the year in US dollar terms. Many analysts are interpreting weak Japanese Government Bond demand as a signal that investors are starting to lose confidence in the effectiveness of unconventional monetary policies, following increasingly desperate bids by the world’s central banks to reflate the global economy. In this environment, we believe investors are using gold to hedge portfolio risk as they add more stocks and low quality bonds to their asset mix.

A perfect storm lifts gold up

The gold price continues to rise, moving above US$1,360/oz. and increasing by almost 29% in US dollar terms year-to-date (as of 8/2/2016). This has been gold’s largest continuous gain since the European sovereign debt crisis in 2010 and 2011. Gold has been one of the best performing assets so far this year, outpacing all major benchmark indices and with comparable volatility to stocks (Chart 1). It has also outperformed commodities such as crude oil, whose prices have plunged since the end of June.

 

Chart 1: Gold has outperformed most asset classes

YTD, 1-year return, and volatility for various assets*

 

YTD, 1-year return, and volatility for various assets*

YTD, 1-year return, and volatility for various assets*

*As of 2 August 2016. Area of the bubbles represent relative volatility. Source: Bloomberg, ICE Benchmark Administration Ltd., World Gold Council Gold’s most recent surge was driven in part by weak demand during the 10-year Japanese Government Bond (JGB) auction on August 2nd, as investors have begun to question the effectiveness of unconventional monetary policies.

Amid rising uncertainty in global financial markets after Brexit and the recent slowdown in emerging market economies, the Bank of Japan (BoJ) announced an expansion of its quantitative easing policies. Specifically, BoJ almost doubled its purchases of ETFs to an annual pace of JPY6 trillion (approx. US$60 billion) and, at the same time, doubled the size of its US-dollar lending program to US$24 billion. Many investors, however, were disappointed, as the market was anticipating larger increases to asset purchases and/or further rate cuts. We believe that the weak JGB auction and ensuing sell-off in global sovereign bonds this week, suggests that investors may be losing confidence in government securities. Gold (US$/oz) S&P GSCI.

At the same time, the European Central Bank has signalled they too will further expand quantitative easing in one form or another, while the Bank of England is also expected to cut rates and/or restart its asset purchase program. As a hard asset, gold has provided an alternative to balance the long term risks of fiat currencies and ineffective monetary policies.