Can Gold Continue Its Strong Run?

There was a lot about the market reaction to Covid-19 that made little or no sense back in March and there still is, but even within that, one of the most nonsensical things was the fact that gold fell sharply alongside stocks earlier this year as the shutdowns began. After all, wasn’t the complete closure of the economy, and the economic and social Armageddon that looked imminent as a result, exactly why we were all told a decade ago that we should be buying gold?

That weakness didn’t last, though, and yesterday, gold hit an 11-year high, with the SPDR Gold ETF (GLD) closing at 169.04.

Let me pause for one second: I know that for the true purist, only physical gold counts, and that the ETF is an abomination that will fall with the rest of the financial system when the end times come. However, for most traders and investors, it is a decent proxy that can be bought and sold quickly and cheaply. For me, as for many others, it is the default way of trading and investing in the metal, so forgive me if I talk about the ETF as if it were "real."

Back to the topic at hand: Most of the time, when I look at a chart such as the below, my finger instinctively hovers over the “sell” button. That is a strong, sustained run up and some kind of a retracement or correction looks imminent based on the chart alone. However, when you consider the fundamental factors that drive gold there is absolutely no reason we can’t just continue to push higher.

I have said in the past that gold is the Kardashian of the investing world. It is attractive to look at and fascinating to follow, but of fundamentally no use to society. That is a bit harsh on the Kardashians, but it is also a little unfair to gold, which does have one other notable property: it is a store of value.

In that sense, gold can be seen as a currency, rather than a commodity. It is priced in the global market in dollars, so its price reacts to strength and weakness of the greenback as much as changes to its own intrinsic value. That relationship is what explains that move in March, as the immediate reaction of big money around the world when a crisis struck was, as it usually is, to buy dollars.

The normally quite steady Dollar Index (DXY) jumped from below 95 to over 102 in just a couple of weeks in mid-March, forcing anything priced in dollars, including things like oil and stocks as well as gold, lower. The difference, of course, is that the crisis that pushed the dollar higher also had a negative effect on the prospects for oil and stocks, whereas its fundamental impact on gold is likely to be positive.

The reaction of governments to the crisis was both predictable and inevitable. They threw everything they could at it, in monetary and fiscal terms. Here in the U.S., for example, the Fed started to buy bonds, which they finance by creating new money in the accounts of the sellers, effectively “printing” vast amounts of cash. Congress, meanwhile, authorized spending measured in the trillions, which blew the federal debt up to well over $23 trillion.

In these circumstances, both of those things were needed, but it does point to the folly of the last few years when, in a strong economy, debt was still increased, and monetary policy remained easy. When a real crisis hits, it becomes clear that those policies were more about not hurting the market’s feelings and creating an illusion of even more prosperity than they were about any economic imperatives.

To put it another way, the supply of dollars, the other side of a gold trade, is increasing massively, lowering the intrinsic value of each dollar. Weak economic demand and slack in the economy means that it has not shown in the price of most goods. Despite the increases in the money supply, there hasn’t been any sign of inflation in the data to this point.

It has, however, shown in the price of gold. The traditional argument against gold as an investment, that it provides no income stream, has also been rendered moot of late. With sovereign debt offering negative rates in Europe and effectively zero in the U.S., that is not an issue. If anything, a zero yield looks pretty attractive.

It seems that every fundamental factor is working in gold’s favor right now. U.S. debt is massive and growing, dollars are being created at an alarming rate, and that is all happening at a time when sustained economic weakness is a real possibility.

On second thought, maybe that chart doesn’t look so bearish after all...