The price of gold is going up, so gear up for some turbulence in the world’s economy. The International Monetary Fund (IMF) forecasts a slowdown in economic growth across the globe.
The recent increase in gold price is in fact proof that the slowdown has already started.
Interestingly though, the increase is not the result of investors seeking a safe haven in a year that seems financially and economically awkward. That is, there are low interest rates in developed economies, higher rates in developing and emerging ones, and hence relatively higher risks of investments.
And there is also no clear indication of where interest rates are headed. There is also an increasing number of countries seeking bailouts, from Pakistan to Ecuador.
In addition to the above, an increasingly protectionist trend could undermine the flow of global trade and negatively impact countries with economies highly dependent on international trade for their diversification.
So, what does all of the above have to do with gold?
First, despite providing no annual returns, gold seems to be the go-to investment when investors are not sure where to park their cash, especially when bank deposits are no longer a financially logical option. This is because of negative or ultra-low interest rates in many developed economies, which haven’t budged much from their 2008 financial crisis levels.
As a result, the alternative is to go for gold and settle for capital return, an increase in gold price which needs to be high enough to exceed inflation plus profit to make purchasing and holding it worthwhile. The trend in gold price seems to be headed upwards, and it may be a good time to get in, even if the best time to get in was when it was at $1,200 an ounce level.
Secondly, and similar to what happened during the financial crisis ten years ago, the increase beyond the $1,300 per ounce level is due to purchases and accumulation by various countries, not individual investors.
In a report by the “Financial Times”, China purchased gold in late 2018, while its last purchase was more than two years ago. Poland, which hasn’t purchased gold since 1998, has lately added to its gold reserves. According to the same report, countries through their central banks have increased their gold purchases by “almost 75 per cent” in 2018.
“The Economist” reports that such purchases are “the highest since 1971, the year the dollar’s peg to the gold price broke”.
Countries that have increased their gold purchases include Russia, with a substantial amount of its purchases coming from gold that is being mined and procured domestically. Other countries include Kazakhstan, which in the past few years broke its peg with the US dollar and have shifted from dollar reserves to gold, as well as Turkey, which is preparing itself for a barter trade system with Iran, when needed.
While it may be early for these countries to tap into the gold market, others may follow as dim prospects for the world’s economy become clearer in 2019. Such a shift will encourage other investors to move into gold with fewer other alternatives available for investments.
Therefore, in light of low interest rates and a lack of clarity with regard to the world’s economic prospects, the gold price is expected to continue climbing. As it does, it may not stop at the $2,000 per ounce level realised two years post the 2008 financial crisis, but possibly higher.
A similar trend was witnessed post the increase in 1971, except that in every cycle, previous records for the highest gold price reached are usually broken. Not only that, the time elapsed between one cycle and the next is getting shorter.
The last thought that I want to leave you with: why are countries shifting their reserves from US dollars to gold?
Abdulnasser Alshaali is a UAE based economist.
