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Gold remains attractive investment option, despite latest surge

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Gold bars in Bundesbank

By Hussein Sayed, Chief Market Strategist at FXTM

After declining 5.4% from the peak reached on May 18, gold is again flirting with the key resistance level and recent multi-year high of $1,764. The resurgence in the precious metal price has coincided with a record increase in coronavirus cases worldwide and as of Friday, the SPDR Gold Trust holding saw a rise in net inflows of 2%.

While many investors do not like gold as an asset class given that it pays no interest, those same investors may find the precious metal a better alternative to many other asset classes.

The stock market rally is clearly losing steam and there isn’t much incentive to keep the bull market running much longer. Equity prices have already discounted the actions taken by central banks around the world and another big round of stimulus is not likely at this stage.

Assuming the S&P 500 remains in the 3,000 to 3,200 range until year-end, it will be trading at a price to earnings (P/E) multiple of 24 to 26 times for 2020, and 19 to 20 times for the end of 2021. That is considered the most expensive market since the dot-com bubble.

This isn’t to say that equities are due a sharp correction, but to continue moving higher they need a fundamental positive surprise on two fronts, economic and earnings, which is currently far from the base case scenario.

What is more important for gold is where fixed income markets are heading next. On Monday, the US 10-year real yields are trading at -0.61%, and when excluding the one day drop to -0.98% on March 9, that’s the lowest level for real yields since 2013, the year when the Federal Reserve delivered a huge shock to financial markets by revealing their intention to withdraw stimulus.

Real yields in Europe are even lower than those in the US, especially in Germany and that is terrible news for people approaching retirement as it seems they are now assured of a pension that will fall in value if they don’t take a riskier approach. And with the trillions of dollars in government and central bank stimulus since the start of Covid-19, we shouldn’t be surprised if inflation begins edging higher. That will be another hit for savers.

The notion that central banks will follow Japan in targeting yield curves is growing.

Keeping short and medium-term yield maturities under pressure may sound like good news for risk taking, but again the price will be paid by the elderly as real yields fall further into negative territory.

This should make gold a great hedge against negative yields, devaluation of currencies, an unexpected surge in inflation or deflation, poor economic performance and shocks in equity markets.

 

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