During throes of COVID-19 panic, the metal delivered on reputation as haven asset — until it didn't
Gold has been long been lauded as an asset that provides safety during turbulent times, which is exactly what the market went endured in February up to March. And the precious metal performed to expectations — at first.
Citing the London Bullion Market Association, the Wall Street Journal reported that from the beginning of February through March 6, gold rallied by 6.6% while the S&P 500 dropped 8.2%. But in the subsequent period from March 9 through March 31, gold shed 4.1% as the S&P 500 went down 9.7%.
The upshot for gold-oriented ETFs and mutual funds, according to Lipper data, has been total returns of -21.4% on average — in line with or worse than many other fund categories. For reference, the average U.S. equity fund declined nearly 24.6%.
One possible explanation, advanced by the World Gold Council in a recent blog post, is that investors sold their gold to cover losses in other markets. Some investors are unable to ride out volatility in equity and fixed-income markets; those who bought stocks or bonds on margin, in particular, must come up with more cash to present as collateral to brokers who make margin calls in case of a market downturn or heightened volatility.
“As a liquid asset, gold was used to raise cash, as it was one of the few assets with positive returns this year,” Aberdeen Standard Investments said in a note. Many investors seeking to survive the pandemic crush also chose to divest themselves of gold as it is typically used as a satellite portfolio holding.
Another driving factor, argued the founder of commodities consulting firm CPM Group, is the use of leverage in the gold market. “If demand for physical gold had been behind the price increase, the price would not have fallen in this way,” Jeff Christian wrote in a recent letter to clients.
The letter noted that investment demand for physical gold contributing little to gold price increases from June to early September 2019, as well as December 2019 through March this year. Instead of bullion-based exposures, buyers have been favoring derivative products such as leveraged futures contracts, options, and forward contracts.
“These leveraged positions were subject to the same liquidity, collateral rules and margin requirements as other financial instruments, and sold off with everything else,” Christian said. As gold price volatility spiked, margin deposits for gold futures and similar contracts also rose, at which point investors could have chosen to dump such investments.
That’s in line with the World Gold Council’s blog post, which noted that there appeared to be more selling “concentrated on derivatives in exchanges and over-the-counter.”
Offering an optimistic take, David Ranson, director of research at financial analytics firm HCWE & Co, proposed that the drop in gold prices may indicate that the worst of the pandemic crisis is behind us. He said that same conclusion is supported by recent action on the 30-year Treasury bond, which hit a low around the same time that gold reached its recent high.
“It’s a sign that the worse of the crisis has passed,” Ranson said.
