Gold: fading the metal’s shine

This should have been the first full week of the Summer Olympics, but the postponement of the games doesn’t seem to have put a dent in demand for gold.

Indeed, the metal has been setting new records itself – hurdling above $1,945 per troy ounce on Monday and racing to a year-to-date return of over 27%.

We are nevertheless lowering our conviction on gold and precious metals after this impressive price action. Why? We believe gold can best be modelled by real yields and the US dollar (we discussed gold as a real asset in a previous blog) and, as both have fallen recently, the shiny metal has enjoyed a tailwind.

The macro environment may well continue to support safe havens like gold, given fears of second waves of COVID-19 and escalating tensions between the US and China. Furthermore, as the hardest currency around, gold may continue to benefit from the printing of fiat money.

However, we need to stay price sensitive too. Gold seems fairly priced at the moment. To move higher from here, we believe we would need to see one of the following: bubble dynamics in the metal, lower real yields, or a weaker dollar.

A bubble is certainly possible in a world awash with liquidity, but gold bugs are everywhere so sentiment is already very positive, making the threshold for continued outperformance higher. Real yields, meanwhile, have already been dampened by the liquidity glut. Finally, we think dollar weakness is less likely to persist, given the currency’s overvaluation is starting to disappear and negative sentiment regarding the greenback is becoming more widespread.

Given these dynamics, we are moving tactically neutral on gold; we believe it will continue to play a safe-haven role over the medium term, but remain conscious that its rally may have overextended itself.