Price of Gold Reaches All-Time Highs

In many ways, COVID-19's affect on global markets has been nonsensical. Equity markets are nearing pre-crisis levels and the overwhelming majority of corporate bonds are yielding less than 2%. With everything that's going on, it's hard to believe that the S&P 500 should be anywhere near the levels we saw late last year. It's hard to believe that the bulk of corporate issuers will have no problems meeting their debt obligations in the years to come.

One corner of the market that has made a lot of sense is gold, which has tracked higher and higher since the worst of the market's sell-off ended in late March:

Source: Bloomberg

Gold reached US$1900/oz in the last few days and is closing in on an important milestone: US$2000/oz. Should it break through that barrier, it could be on track to run significantly higher.

They Can't Print Gold

Gold hasn't had a strict tie to actual currency since at least the mid 1970's, when the US abandoned the gold standard and the world adopted the US dollar as the global reserve currency. Abandoning the gold standard allows central bankers a lot more flexibility with monetary policy, which (for proponents of the gold standard) is where the problems started. We've noted before that central banks have been extremely aggressive in their response to the coronavirus pandemic - cutting rates to near zero and buying billions of dollars in assets to support credit markets and financial systems. That aggressive response would not be possible on the gold standard, where central bankers are limited by the amount of gold they hold in reserve.

Part of the thesis that's driving up the price of gold right now is that while the US Federal Reserve and Bank of Canada can print enormous sums of money and issue billions upon billions in debt, they can't print new gold. While a flood of new dollars can be produced with the flick of a pen, the production of gold is limited by its abundance and accessibility in the ground. Jerome Powell and Tiff Macklem can increase the supply of dollars with a press conference, while Newmont and Barrick have to do significantly more work. If aggressive monetary policy causes any kind of inflation, that bodes well for the dollar value of gold.

How a Higher Gold Price Affects the Market

Firstly, and most obviously, the price of gold affects the economics of gold mining, and the prospects of everyone from senior gold producers to junior exploration and development companies. Companies of different size and scale have responded very differently to the coronavirus pandemic and the associated runup in the price of gold. The chart below shows how shares of three different gold companies, and gold itself, have performed over the course of 2020:

Source: Bloomberg

The orange line is gold itself. The yellow line represents shares of Newmont Gold Corp., one of the largest gold producers in the world, which responded positively to the market sell-off in March and has hovered between a 40- 60% year-to-date gain since then. The green line shows Yamana Gold Inc., a midsize producer, which was hit hard by the March sell off but rallied to a YTD gain of over 60%. The blue line is Triumph Gold Corp., a junior exploration and development company which lost more than half its value at the bottom and has since rallied to an 83% YTD gain.

That's broadly how the coronavirus pandemic has affected the gold space. Gold itself has seen a steady run to a 28% YTD gain. Major producers were affected positively by the selloff and have had a great gain for the year. From there, the smaller the company, the higher their sensitivity to market volatility and the price of gold.

Our Outlook

We're not quite as enthusiastic about gold as some people, but it's hard to deny that this is a great time for gold. On one hand, if central banks continue their aggressive quantitative easing programs, we expect to see some inflation. If central banks don't continue to support credit and financial markets, we can expect some pretty grim economic outcomes. In either scenario, gold will be an in-demand investment.

Gold performs well in two conditions: when investors are scared of everything else, and when central banks start printing money. Since it's not unreasonable to expect both those conditions to persist for some time, gold might be able to go well above $2000/oz.

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