Gold's Bitter Battle Against a New Breed
Updated: Dec 10, 2020
Gold has been one of the most volatile assets to trade this year: whipsawing from a low of $1470 to over $2000 against the backdrop of repeatedly changing outlooks.
In its process of creating a number of winners, we’ve also seen sudden drops in price that have caused some large portfolio losses: we’re here to help minimize those mistakes going forward.
Here are 3 things to look out for when trading gold.
“Let’s take a break.”
As the past few weeks have shown, sometimes the Gold-USD relationship takes a break from its usual dynamic: transposing from a generally inverse relationship into more of a synonymous one instead.
Figure 1: Gold and the USD abandon their main roles mid-month
This relates to young investors because we get burned when assuming that gold prices should soar as the dollar weakens: in other words, when we believe that the general trend should always hold true. Instead, taking a step back and observing why the relationship isn’t working at some point is a better strategic option: specifically if we look through the macro-level lens (i.e. the bigger picture).
“Introductions of vaccines and a pro-Biden presidency have produced a remarkable “risk-on” sentiment, which means that investors naturally start moving their money out of safe-haven assets (gold) and into more volatile ones (equities) instead.”
Because of this overarching development, the lines around Gold-USD’s once-established relationship have begun to blur, bringing us to the following question:
How has the outlook for Gold changed going forward?
For the most part – among both professional investors as well as retail ones – it hasn’t.
Our thesis is that, given this ubiquitous appetite for risk assets at the moment, there’s a slight lag in gold prices. In other words, the inverse relationship will materialize at some point, it just won’t be immediate.
Figure 2: Gold price outlook in the near-term
If the paradigm above holds true, young investors would benefit from nibbling on gold at the moment – buying in low quantity but slowly building a longer-term position as the fundamentals eventually begin to drive sentiment once again in the coming weeks.
Wait, Bitcoin who?
Another popular narrative around gold price movements is its relationship – or replacementship – with Bitcoin.
“Do I think it’s a durable mechanism that could take the place of gold to a large extent? Yeah, I do, because it’s so much more functional than passing a bar of gold around.” – Rick Rieder, CIO BlackRock.
If the Chief Investment Officer of a $7 trillion powerhouse is suggesting a move towards cryptocurrency assets, the outlook on gold becomes marred by the following question:
A) How might future investments into Bitcoin actually be made? Will it be done through new money or will asset managers move money from gold to the cryptocurrency instead?
The former scenario creates a relatively trivial impact on gold: in other words, as long as institutional capital is still invested in bullion, prices will likely remain steady even if some extra cash is allocated to Bitcoin in the near future.
The latter strategy, on the other hand, is what creates the first fundamental/structural break for long-term gold prices. The movement of money out of gold and into Bitcoin instead will almost certainly push gold prices down: think of it almost like a scale tipping in favour of cryptocurrencies when weight is moved from one side onto the other. Although unfavourable because of its uncertainty, this is a paradigm we're slowly starting to see more often...
"The Grayscale Bitcoin Trust has seen inflows of almost $2 billion since October, compared with outflows of $7 billion for gold funds, according to JPMorgan" - Eddie Spence, Bloomberg
Figure 3: JPMorgan showing flows out of Gold funds and into Bitcoin
So…What Should Beginner Investors Do?
Aside from nibbling on gold, young investors can consider the two proposals below:
1) Closely watch the allocation of capital: use websites such as www.bitcoinexchangeguide.com to track the market capitalization of Bitcoin and simultaneously see how the money flows into Gold are progressing, with portals such as www.seekingalpha.com, www.globalminingreview.com, or a Bloomberg subscription. Monitor the flows into each on a weekly (or even monthly) basis to see where the long-term trend might be heading.
2) Have a claim on the upside but protect your downside: assuming that you’re teething on gold, also deploying a small amount of your cash into BTC would allow you to benefit enormously if the cryptocurrency reaches $100,000 (as some suggest it will) but concurrently risk almost no money. Even if the dynamics turn sideways and Bitcoin goes to 0, you’ll still only lose a minuscule proportion of your overall portfolio with this type of high-upside-low-downside strategy: making it an ideal long-term play.