Is Gold a Bad Investment Amid the Current Financial Turmoil?
The month of March has been one of the worst months in the history of stock markets, and we are only at the beginning of what is expected to be a tumultuous time in the global economy. Massive selloffs have been taking place in the financial markets, with optimism at near-zero levels. The oft-touted bear market is here. It will take a lot more than a few updates from the White House, and other world leaders to restore confidence to the global markets.
Source: Oil Price (16 March, 2020)
The world is now in the midst of an all-out financial crisis; a vaccine is 18 months away at best. This pandemic has hit the financial markets well ahead of time - thanks to widespread fear and uncertainty resulting in loss of confidence, productivity declines, and a veritable standstill in demand. This has not been helped by the ongoing oil price war between Russia and Saudi Arabia.
Currently, Brent crude oil is trading around $31.41 per barrel, and the US equivalent WTI crude oil is trading at $28.86 per barrel. Demand for oil has all but evaporated from the markets, and accelerated declines are tipping the markets into an abyss. The energy markets too have endured their worst period in history, worse than the oil price shocks of the 1970s. This naturally focuses everyone's attention on the traditional safe-haven asset that investors flock to in times like this - gold.
Why Is the Gold Price Falling?
The current financial crisis makes the 2008 Financial Crisis look like a cakewalk, and we are nowhere near the bottom. With the safety nets removed, traditional safe-haven assets like gold are failing to slow the catastrophic declines in the financial markets. Gold is no longer acting like a hedge against volatility. It appears, at least in the short-term that people are starting to lose confidence in the entire financial system. It's worth examining why the price of gold is plunging, and not rising at a time like this. For starters, there is no confidence whatsoever in the financial markets. People have seen their 401(k) retirement portfolios evaporate into thin air. What remains is a semblance of the once-mighty returns that Wall Street generated for so many years.
Gold, a traditional safe haven against volatility, is not faring well. This is due in no small part to the lack of confidence people feel in general, driven in large part by mass layoffs (voluntary or otherwise), the shutdown of many industries and services (air travel, cruise lines, hotels, trains, buses), the shuttering of sports events across the world, and a suffocating blanket of the darkest possible pessimism we have experienced in recent memory. It is against this backdrop that the Federal Reserve Bank decided to act.
The Fed cut rates by 100 basis points, dropping the interest-rate as close to 0 as possible. Additionally, the Fed will be buying $700 billion worth of bond holdings in a QE program designed to inject liquidity back into the economy. This move will flood the market with dollars, and weaken the currency at the same time. This will make US exports cheaper, but make imports all that more expensive.
Source: Gold Price (March 16, 2020)
Central banks around the world are acting similarly. The Reserve Bank of Australia, The Reserve Bank of New Zealand, The People's Bank of China, The Bank of Japan, The Bank of Canada, The Bank of England, The Bank of Israel, and scores of others are on the same page. Rates are coming down fast. With so many countries reducing interest rates to near zero, there is a complete loss of confidence in the financial markets. Usually, rate cuts bode well for those who trade gold. Gold does not do well when interest rates are high because there is an opportunity cost of investing in gold when you could earn money with fixed-interest-bearing investments.
The flipside of the coin is that low interest rates mean that no gains stand to be made with banks and fixed-interest-bearing investments, so this naturally bodes well for gold. If the world's premier indices like the S&P 500, the NASDAQ, and the Dow Jones continue to plummet, we will see cash reserves drying up, with nothing left to be funneled into gold. That's why the extreme pessimism is negatively impacting gold. What we are experiencing is not simply an isolated event in one country that is driving investors towards safe-haven assets; this pandemic has left the entire global community shell-shocked, and everybody is holding onto what little they have left, for dear life.
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