Spot gold surged past $2,000 an ounce for the first time ever on Tuesday, and prices kept climbing on Wednesday.
Gold is up more than 30 percent this year – placing it among the best before assets. What is driving the relentless rally in all that glitters? And how much higher could gold prices go?
Hold on, rewind a second. What do you mean by ‘spot’ gold?
Spot gold refers to the price of an ounce of gold right now, at this moment in time, as opposed to some point in the future.
And why worry about the future?
Gold investors worry a lot about the future. That helps explain why gold – like other precious metals – also trades on the futures market.
What is the futures market?
That is an exchange where buyers agree to take possession of gold from the seller at a future date, but at a price agreed upon by both parties in advance.
Any other basics we should cover first?
Gold also trades through funds that offer investors exposure to gold bullion, gold futures and companies that mine gold, without having direct ownership of the metal.
So what’s driving this rally in gold prices? Let me guess- the pandemic?
You win a gold star because yes – it is primarily the massive economic disruptions triggered by the pandemic that are driving gold higher, as well as the response to them from governments and central banks – especially the United States Federal Reserve – not to mention opacity surrounding the path of the virus and mounting geopolitical tensions.
A long sentence, I know. But put it all together, and you have one powerful cocktail of uncertainty.
I get that the global economy is in bits. But how is the Fed driving gold higher?
The Fed and other central banks aren’t doing it on purpose. It’s more of a consequence of the fact that the central banks are pretty much doing whatever it takes to keep their economies from seizing up.
The Fed for its part has kept credit flowing to US households and business by keeping borrowing costs low – which it’s achieved by slashing its benchmark interest rate to zero and buying hundreds of billions of dollars worth of bonds. The Fed has also made sure that there are plenty of dollars available globally to businesses that want them – because the US dollar is the world’s reserve currency.
These Fed moves have weakened the dollar and lowered investor returns on bonds. That makes gold look like a far more attractive investment by comparison.
What about the US government response: How does that factor in?
Congress has passed trillions of dollars in virus relief aid to help the US through the pandemic. And Democrats and Republicans in Congress are currently negotiating another round of relief that could see them spend trillions of dollars more.
To put all of this spending into perspective – the US federal budget deficit clocked in at $2.7 trillion in the first nine months of fiscal year 2020. That’s $2 trillion more than the deficit recorded during the same period last year.
That record-shattering deficit, combined with ultra-low interest rates, has depressed the value of the US dollar to the point where some are questioning whether the mighty greenback’s role as the global reserve currency is sustainable in the long run. That makes gold a more attractive investment relative to the dollar because the precious metal is seen as a hedge against currency depreciation.
So when investors turn sour on currencies, gold prices jump?
It’s not just currency depreciation – gold is seen as a hedge against all sorts of potential downside risks. Take the stock market, for instance. The major US indexes have been on a tear since they tanked in March. But if there’s a resurgence of the virus that triggers more lockdowns that kick the legs out of from under the economy again, then it’s quite possible stocks could suddenly turn tail and go lower again. Gold can serve as a hedge against those potential losses.
And the US and China tensions?
That heaps even more uncertainty into an already cloudy outlook. But explaining the myriad consequences of the US-China decoupling here would use up a lot of space, so I suggest you go deeper by reading this excellent analysis.
$2,000 an ounce – I’ve got major FOMO. Could gold prices go higher from here?
Nothing is certain. Especially when investing. But analysts over at Goldman Sachs think gold could go as high as $2,300 an ounce. And back in April, Bank of America raised its 18-month price target on gold to $3,000 an ounce. But again, nothing is certain. No matter what the gold bugs say.