Gold can play an important role against an uncertain outlook for markets.

It’s been a wild ride for most asset classes lately and gold – historically one of the popular safe havens for investors in times of uncertainty – is no exception. After climbing higher during the early phases of the coronavirus pandemic, prices fell to below $1,500 per troy ounce in the middle of March. They have since risen sharply to above $1,700 by the middle of April. We believe they could continue to rise throughout 2020 against an uncertain outlook for the world economy and financial markets.

Why did gold sell off?

Traditional thinking suggests that in this period of greater uncertainty, gold should have rallied – but other forces have also influenced prices. Gold ETFs did see large inflows at the beginning of March, which then slowed. In the second half of the month, margin calls as well as selling by risk-parity funds (which hold gold in addition to fixed income and equities) helped push prices lower. Physical markets were also weaker. China is the biggest buyer of physical gold and reduced airfreight options into the mainland have been a headwind for prices.

I thought gold rallied during the 2008 financial crisis?

The initial pattern of prices was similar to what we’ve seen recently. As the financial crisis unfolded, real rates and the dollar both spiked and gold sold off materially before bottoming in the fourth quarter of 2008. Aggressive action from the Federal Reserve (Fed) put a cap on real rates and quantitative easing (QE) eventually led to material US dollar weakness. Both of these factors fueled gold’s rise up to all-time highs shy of $2,000 (see figure 1).

Figure 1: A glittering performance

The uncertainty created by the 2008 global financial crisis pushed the price of gold higher.

Model assesses gold prices relative to change in the US dollar and US 10-year real interest rates.

Past performance is not a reliable indicator of future results. You may not invest directly in an index.

Figure is a chart showing the upward trajectory of actual gold and a model which assesses gold prices relative to change in the US dollar and US 10-year real interest rates.

What has happened since? 

A combination of aggressive monetary policy easing measures (by the Fed and other major central banks) and extensive government fiscal stimulus efforts have pushed real interest rates lower and helped gold prices rebound.

Wait, explain that stimulus part again? Shouldn’t global fiscal stimulus, which helps growth, be bad for gold?

Not exactly. Remember, real interest rates are equal to nominal interest rates minus inflation. The Fed’s QE program should prevent nominal 10-year yields from moving too much higher because it will keep long-term rates anchored. Additionally, there are sizable near-term risks to the global economy, which is almost certainly about to suffer a recession. Over the medium term, fiscal stimulus should help support growth and, subsequently, inflation. We believe that stable nominal yields and lower inflation will push real rates lower. Furthermore, as growth rebounds, the US dollar should weaken as it no longer has a large carry advantage over other currencies. The 2009 to 2011 period may provide a good template. Although the global economy had recovered from recession, gold prices rallied strongly.

What do you think of gold moving forward?

We see scope for gold prices to move materially higher from current levels. The Fed’s actions of cutting interest rates to zero should limit the appeal of long US dollar carry positions. Global stimulus measures should also support growth and help stimulate economic activity in the medium term. When combined with strong forward guidance from central banks globally, these policies should help keep real rates under pressure – again similar to what we saw in the earlier part of the past decade.

What’s the bottom line?

Gold prices could move to $1,725 by year end ($1,700-$1,750/oz range) with risks biased higher.

How much gold should I consider owning in my portfolio?

In the past, gold has enhanced portfolio returns on a risk-adjusted basis. Based on our analysis of performance since 2005, we conclude that an allocation of at least 5% to gold could enhance portfolio performance for certain clients (20% is optimal but probably unrealistic for a diversified portfolio). We believe adding gold to a portfolio has the potential to improve long-term returns, while also reducing the volatility of performance (in other words, this approach improves the Sharpe ratio).

There are many ways to invest in gold, including physical bars, exchange traded funds (ETFs), options and structured products, and it is important to consider the different risks and potential rewards. Please reach out to your J.P. Morgan team to discuss the best approach for you.