A recent article in The Wall Street Journal offers a guide to the gold market, which hit an all-time high during the pandemic.
Here are key takeaways from the article:
- The price of gold has spiked by 30% in 2020 (as of the article’s August 17th publishing date), “soaring about $2,000 a troy ounce for the first time in New York trading.” Note: A troy ounce is the equivalent of 14.6 ounces to a pound versus the standard 16 ounces.
- The gold market consists of two closely-linked components: The physical market for the precious metal, which includes miners, jewelers, central banks and investors, and dates back to Brazil’s gold rush of 1697; and the futures market (hosted by New York’s Comex exchange), in which financial contracts for based on gold are bought and sold.
- The futures market “gives investors an opportunity to speculate on gold prices rising or falling without holding the metal, and miners a way to insulate themselves from unexpected price drops.”
- Recently, more investors have taken delivery of gold on the Comex, “a sign that demand for physical gold is unusually high.”
- Gold usually costs about the same in both the physical and futures markets. If prices get out of alignment, banks respond by buying cheaper bullion and re-selling where prices are higher. But the pandemic has “scrambled this self-correcting mechanism in March. A dearth of flights led to fears of a shortage in New York, sending futures well above spot prices in London.” Even though the concerns proved unfounded, the “violent price moves led to losses at banks” which prompted them to trace less actively on the Comex which, in turn, could make futures more volatile.
- “Investors who want exposure to gold prices without the hassle of storing bullion or trading futures found an alternate solution in 2003: exchange-traded funds. These funds, which have surged in popularity, buy gold and issue shares that trade on the stock exchange.”
- Professional fund managers bet on gold through futures contracts. Smaller investors typically purchase physical gold bars and coins (single-ounce bars are popular).
- The primary reason for the spike in gold prices is this year’s drop in U.S. Treasury yields to “levels below the expected pace of inflation.” Since gold doesn’t pay income to investors, they miss out on yields from other asset classes when interest rates are high. When bond yields are negative, however, gold’s lack of yield becomes appealing. The Fed’s slashing of rates and massive bond purchases has pulled down yields and triggered gold buying.
- Gold investors believe that it will hold its value if stock prices fall.
- The depreciation of the dollar also increases the appeal of gold: “Buyers outside the U.S. are willing to pay a higher dollar price when the greenback weakens, making gold cheaper in terms of their home currencies.”