Covid-19 effects on Gold

Marius Paun | London, UK | Senior dealer | Tuesday, 05th May 2020

Early this week the Swiss investment bank UBS said that the price of gold has the potential to break $1800 per ounce in the near term. The analyst supported his claim with ‘growing investor interest in an environment of uncertainty and negative interest rates’.

At the end of April another major investment bank, Bank of America, made an even bolder prediction, ‘Gold is set to hit $3,000 per ounce in the next 18 months’. That would be more than 50% higher than the all-time record high of just over $1900 set in 2011. The reason for such a prophecy? ‘The US Fed cannot print gold’.

Hardly anyone doubts the world economy has been hurt enormously by the coronavirus pandemic and the extraordinary measures taken to combat it. It’s now rather clear that most countries will report double digits declines in GDP figures for at least one quarter. Yes, it is true these exceptional downturns have been met by exceptional responses. The best indication is that central banks around the globe seem to be working side by side with governments. One side is printing money out of thin air to give to the other side, which is spending it at a jaw-dropping rate. Unfortunately, someone will need to pay for that in the end and the widespread consensus out there is that those respective currencies will be devalued as a consequence. That’s where gold could come in quite handy. It should be noted that a strong dollar, supported by a panic selloff (as we had in mid-March this year), could slow gold’s optimistic outlook, even if only on a temporary basis.

It is often quoted that gold is a good hedge against inflation or, better said, against the fear of inflation when financial assets are in danger of losing their real value (nominal price less inflation rate). But the real immediate threat brought by the current pandemic is a deflationary shock at least on the short term. So why is gold not going down? Many central banks are attempting to keep rates at near-zero or even negative levels as long as they can get away with. Any saver earning 1% or less in interest has been moaning for a long time that this is lower than inflation. So, the real value for savers has been eroded to the benefit of banks. Thus it is not about deflation per se, pricing going down or stagnating which includes interest rates, but the fact that real rates are negative (nominal rates less inflation) that’s important here. This so-called ‘financial repression’ is about a transfer of wealth from creditors to debtors. It’s been happening for quite a while and at some points, savers might want an alternative to the current arrangement.

The World Gold Council has recently released its first-quarter report saying total gold demand grew to over 1,083 tonnes year on year. They emphasized that the coronavirus outbreak was the single biggest factor influencing gold demand in Q1 as scared investors were desperately looking for safe-haven assets. Holdings in Gold-backed ETFs rose by 298t to an overall new record high of 3,185t.

Gold demand fell to the lowest figures on record led by a 65% decline in China which was first to feel the effects of Covid-19. Central banks continued to buy gold albeit at a slower pace which is expected to reduce even further in the near future. Gold supply dropped by 4% as the lockdown measures hurt precious metal mining and recycling. Transporting gold to refineries and from there to the dealers has also become a serious challenge.

During the current week, gold prices were relatively stable, around the $1700 mark. On one hand, we saw a string of negative economic data with the US GDP declining 4.8% in the first quarter and factory orders posted a record drop in March. New orders fell more than 10% from February to March, the biggest fall in records dating to 1992. But that was counterbalanced by a stronger US dollar.

The chart shows gold in a consolidating phase currently. The price is now close to both short and long term moving averages. We note the 6 days MA has just crossed below the 21 days MA. One could be tempted to say this gives a bearish signal, but in a sideways short-term trend, those signals are not very reliable.

On the downside, the first target is resistance turned support around $1690 mark which held well this morning. If sellers manage to push gold below that level, support at $1679 will come into focus followed by $1670. On the way up, bulls have their eyes on $1720 as the next target. If the long-term uptrend is to resume, a close above the recent high of $1746.7 is needed.