Mobeen Tahir (Wisdom Tree) | Following weakness in prices around the middle of March, when liquidity needs created acute selling pressures on gold, the precious metal has resumed its strong run this year with more than 13% price appreciation year to date.
Two important forces are driving the strong demand for gold at present. Firstly, the ongoing coronavirus pandemic has created a high degree of economic uncertainty with the International Monetary Fund and major central banks around the world forecasting a sharp slump in global gross domestic product in 2020. Investors appear to be turning to gold to hedge against downside risks to cyclical assets like equities in their portfolios.
Secondly, forceful monetary accommodation from central banks to sustain the economy has raised the risk of devaluation of paper currency through rising inflation once the pandemic ends and economic activity starts to pick up again. We believe, this is most likely to happen in 2021 in a U-shaped recovery scenario. Therefore, it appears that, investors are also turning to gold to hedge against the risk of rising inflation.
This thesis was supported when gold prices found additional support on 12 May when warnings came from members of the Federal Reserve regarding businesses becoming bankrupt and from Dr. Anthony Fauci regarding a premature end to the lockdown being a risky move. Markets were reminded of the risks to the U-shaped recovery story, including further downside for risk markets and the need for additional monetary stimulus, which gave further support to gold.
Other precious metals including silver, platinum and palladium are more industrial in nature. Their recovery since March has been relatively contained compared to gold due to headwinds facing base metals from weak industrial demand amid lockdowns around the world. Price movements for all three have been negative year to date, more in line with the industrial metals complex. Among the three, silver has the highest correlation with gold and is up around 4% in May, while platinum and palladium are still negative this month. Going forward, we expect silver to continue to benefit from its correlation with gold. The three industrial precious metals, however, are being reactive to demand conditions and will truly begin to shine once economic activity resumes and demand conditions improve as a result.