Source 1: BullionVault.com
Whilst the stock market has been in turmoil, gold prices have been trading at a seven-year high amid the coronavirus pandemic. This odd trend of increasing gold prices even whilst the stock market dipped to new lows was also observed in the aftermath of the global financial crisis (GFC) from 2008 to 2012. Could this coronavirus crisis be a replay of the GFC – a re-run where Australian markets join the rest world in coming under fire? This article discusses the underlying reasons for the rise in gold prices, using the most basic and fundamental concepts of supply and demand.
Suspension of gold production
On a surface level, the rise in gold prices can be most simply explained by the disruptions in the supply chain. After declarations of lockdowns to curb the spread of the coronavirus, production of gold mines and gold refineries were partially suspended, thereby constraining the gold supply.
Shortage of physical gold for delivery
Constraints in supply are also evident from the widening gap between gold’s futures and spot prices. Gold futures are now more than $50/oz over spot prices, raising concerns about a shortage of physical gold for delivery on future contracts. This means that speculators holding paper gold may not be able to redeem physical gold, simply because there are not enough physical gold bars to meet the surging demand.
There have also been concerns relating to Australian household leverage, resulting in a shift to gold as a medium of storage of wealth. While the GFC forced the rest of the world to reappraise their leverage and wealth, property prices in Australia have continued to inflate. As property prices become increasingly inflated, households cashing in on the rising value of their properties by taking up further household debt create a vicious cycle of increasing debt and property prices. Consequently, the household debt-to-income ratio has reached an all-time high of 190%.
These figures indicate that households may increasingly experience difficulties meeting their debt obligations. Recent figures from the Australian Bureau of Statistics’ (ABS) data indicating that the unemployment rate in April was 6.2% due to the lockdown merely exacerbate concerns of an increase in default rates.
In scenarios like these where inflated property prices may experience a significant decline in value, gold serves as a better hedge against inflation.
The increased demand for gold also stems from global economic policy responses. In response to the coronavirus crisis, the Reserve Bank of Australia (RBA) has recently implemented quantitative easing measures. These include cutting the interest rate to a record low of 0.25%, and purchasing government bonds and other financial assets from banks and pension funds. All of these expansionary monetary policies are implemented to pump funds through the financial system in the hopes of stemming impending recession. This scenario is not just limited to Australia alone. Other countries like United States, United Kingdom, Europe and Japan have also been implementing similar expansionary monetary policies by taking up higher levels of sovereign debt. The financial system is expected to be flooded with excess money, resulting in risks of hyperinflation. Thus, this is becoming one of the reasons for investors to increase their allocation of gold in their portfolios to serve as a better store of wealth relative to paper notes.
This coronavirus pandemic appears to be the pin to finally burst the global economic bubble that has been driven by rising personal and government-level debt. Amid this process of deleveraging and period of market volatility, gold appears to be the “safe haven” asset compared to other traditional asset classes.
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