Still unconvinced about whether or not you should invest in gold? Allow us to help you make your assessment, from a financial perspective…
With the markets behaving as volatilely as they are, the ever-present reservation and wariness to invest—and for that matter, the concern over what is safe to invest in—is completely relatable. After all, the goal of investing is to grow, or at the very least, to retain your wealth. Any losses should be minimised, or at best, avoided.
So, what about gold?
We’re not here to rehash the pros and cons of owning gold, but rather, help you make an informed decision by appraising the value of gold in these three ways.
1. Gold versus Real Interest Rates
In a previous article, we discussed how real interest rates (i.e., nominal interest rates minus inflation) make a strong predictor of gold prices. Specifically, it has been observed that a negative correlation exists between gold and real interest rates. Therefore, when real interest rates are high, then the price of gold drops. Reversely, when real interest rates are low, then the price of gold rises.
Using this correlation as the basis for our appraisal for the value of gold, we can then see, based on the chart below, that the current market favours gold. Ceteris paribus, if real interest rate (now hovering around -0.5%) is allowed to decline further to 3% on the back of higher inflation, then gold prices should increase to around US$2,500/3,000.
2. Gold vs USD
Previously, we’ve also argued the merits of considering gold as a currency instead of a commodity or an equity, or even an inflation hedge. The correlation between gold and the USD (represented by the Dollar’s Trade Weighted Index) can be seen in the chart below. The question then, of course, is this: where is the USD heading?
Source: Board of Governors of the Federal Reserve System (US); Author’s addition
Given that the US currency is increasingly decreasing in value (due to the massive printing of money and ultra-low interest rates), we foresee that the underlying foundation of the USD will remain weak in the near future. Furthermore, with the US economy in need of every help it can get, a weaker USD would complement ongoing efforts from the fiscal and monetary side.
While trying to predict the level of decline of the trade-weighted US dollar index is tricky, we can reasonably infer, from the 16% decline seen during the 2009-2011 period, that the trade-weighted USD index could decline up to another 10% (thus far we’ve only seen a 6% decline from its 2020 peak). Based on our estimates, a further 10% decline in the trade-weighted USD could boost gold prices by US400-600 (to USD2,400-2,600 from its current US$2,000 level).
3. Gold vs Quantitative Easing
Lastly, a method we can use to predict gold prices is the level of quantitative easing by the U.S. Federal Reserve (Fed). Here, the price of gold is measured in relation to the increase (or decrease) of assets under the Fed’s balance sheet. Typically, it has been observed that when there is an increase in such assets (usually also implying an increase in the amount of money that is being printed), gold prices relatively tend to rise.
The chart below highlights this point. As we can see, there were two major spikes in the Fed’s assets—first during the 2009 to 2015 period when the balance sheet expanded from approximately US$800 trillion to US$4,400 trillion, and the second spike from 2019 to our present day when the sheet expanded from US$3,800 trillion to US$7,200 trillion. In both cases, we observed a corresponding increase in gold prices. From 2009 to 2015, gold went up from US$400 to US$1,200. Likewise, from 2019 to present day, gold went up from US$1,200 to US$2,000. A secondary observation that can be made from this example is that every time the balance sheet increases by around US$3.5 trillion, gold prices rise by US$800.
Source: Board of Governors of the Federal Reserve System (US); Author’s addition
Presently, the general consensus in the market is for the Fed’s balance sheet to rise to US$10 trillion, with some even expecting a spike up to US$20 trillion. Using our earlier observations as a precedent, we can then make an educated guess that if Fed’s assets increase up to US$10 trillion, the price of gold would fall somewhere in between US$2,500/3,000.
Summary
Based on all 3 valuation methods, we can see that the price of gold is forecasted to settle around US$2,500-3,000, which corresponds to a 25% to 50% increase from present prices. Notably, this does not take into account any overshooting that typically accompanies such rallies. However, as in all forecasts, past performance does not necessarily represent future performance.
Investors looking to ride the current “bull cycle” must do so with caution given the volatility associated with investing in gold, and should always seek the advice of a licensed financial consultant who would be able to determine important factors such as the investor’s risk tolerance and the amount of cashflow available for investment.
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