The Covid-19 pandemic and the lockdown it caused have wreaked havoc in the South African economy, but the gold price has been soaring. Gold Fields has been quoted as saying that booming gold prices could drive up half-year profits by more than 300%, triggering a 10% share rally. Reuters reports that the mining company may have had to shut its operations, but it had already said the Covid-19 pandemic would have a limited negative impact on its performance. So what’s behind gold’s record-breaking bull run? This Wall Street Journal article explains how the market works and what drives the price, and gives us the knowledge that the holds of passenger planes sometimes carry more than suitcases full of crumpled clothes. In good times, gold costs about the same amount on Londonâs physical market as it does on New Yorkâs Comex exchange. If prices move out of sync, banks bring them back in line by buying bullion in one city, flying it across the Atlantic (normally in the cargo hold of a passenger plane) and selling it at a profit. Covid-19 put paid to those flights which led to fears of a shortage in New York, sending futures well above spot prices in London. There’s a gold lining to the Covid-19 cloud, it seems.- Renee MoodieÂ
Why gold prices are hitting all-time highs
By Joe Wallace
Gold prices are on track to notch new records this week, after closing at over $2,000 a troy ounce for the first-time ever on Tuesday in New York trading. That marks a fresh milestone in a bull run that began in late 2018 and has gathered momentum during the coronavirus pandemic. The precious metal has soared almost 35% in 2020, outstripping the rally in the Nasdaq Composite Index of highflying technology stocks.
___STEADY_PAYWALL___
Here is how the gold market works, and why prices are on the rise now.
What is the gold market?
There are two gold markets, closely linked because investment banks and other big players are active in both.
The first is the physical market, which brings together miners, refiners, jewellers, central banks, electronics manufacturers, banks and investors. London is the focal point, dating back to the first gold rush from Brazil in 1697. Shanghai, Zurich, Dubai and Hong Kong are also hubs.
The second market is the futures market, for swapping financial contracts based on gold. This market is electronic, hosted by New Yorkâs Comex exchange, and sets the prices you read about in The Wall Street Journal. It gives investors an opportunity to speculate on gold prices rising or falling without holding the metal, and miners a way to insulate themselves from unexpected price drops.
How does the physical market work?
Deals to buy, sell and lend gold in London are struck privately, rather than on an exchange. To reduce the amount of metal that has to be shunted from vault to vault, five banks act as a clearing house, balancing out each otherâs sales and purchases. Some of them provide vaults, offering clients a safe place to stash gold. The Bank of England guards more than 400,000 bars beneath the narrow streets of the City of London, largely on behalf of the U.K. government and other central banks, a hoard second only to that of the Federal Reserve Bank of New York.
Read also: Mark Mobius: âIâd buy gold and silverâ
Prices are quoted by troy ounce (14.6 troy ounces to the pound, instead of the standard 16) of pure gold, and bullion trades in batches of 400-ounce bars. London prices are fixed in twice-daily auctions and act as a benchmark throughout the physical market. When a watchmaker buys gold from a refiner, it usually does so at a premium to the London price.
To avoid paying for tons of gold, tying up millions of dollars in cash, industrial users often borrow metal instead of buying it outright. Banks either lease it to them, charging interest, or lend with more complex forward, swap and repurchase deals.
How does the financial market work?
Futures are standardised contracts that lock in prices for gold that will change hands at a specified date. Buyers and sellers agree to swap 100 troy ounces (a new Comex contract that allows delivery of 400 ounces has barely traded). Gold futures trading data go back to the final day of 1974, when Comex launched the market to coincide with a law allowing Americans to own bullion for the first time in four decades.
Most traders exit futures trades before they actually exchange gold. Recently, however, more investors have taken delivery of gold on the Comex, a sign demand for physical gold is unusually high.
How do the physical and futures markets interact?
In good times, gold costs roughly the same amount in Londonâs physical market and on New Yorkâs Comex. If prices move out of whack, banks bring them back in line by buying bullion on the cheap in one city, flying it across the Atlantic (normally in the cargo hold of a passenger plane) and selling at a profit where prices are higher. They must factor in the small sum it costs to recast the gold, since Comex requires smaller bars, weighing either 100 troy ounces or a kilo.
The pandemic scrambled this self-correcting mechanism in March. A dearth of flights led to fears of a shortage in New York, sending futures well above spot prices in London. The concerns proved unfounded, but the violent price moves led to losses at banks including HSBC Holdings PLC. That has prompted banks to trade less actively on the Comex, which could make futures more volatile, said David Govett, head of precious metals at brokerage Marex Spectron.
How do investors buy and sell gold?
Professional fund managers bet on gold prices with futures. To avoid taking hold of a large amount of bullion, investors typically sell futures before they expire and buy later-dated contracts, in a process known as rolling. This comes at a cost because longer-dated futures cost more than spot gold. The difference is pocketed by the investorâs counter-party â normally an investment banker â who gets to buy low and sell high.
Mom-and-pop investors buy physical bars and coins, which they can either stow at home or in a vault. One-ounce gold eagles, produced by the U.S. Mint and sold by dealers like Kitco Metals Inc., are among the most popular.
Demand for bars and coins has shot up during the pandemic, said Robert Higgins, chief executive of Argent Asset Group, though clients are also selling to profit on rising prices.
âWhen things go crazy and the surety of everything is questioned, the two things everyone turns to are gold and silver,â he said. This wasnât always the case: In 1933, Franklin D. Roosevelt ordered Americans to hand over all gold coins, bars and certificates to banks, seeking to staunch a rush to exchange paper money for bullion during the Great Depression.
Investors who want exposure to gold prices without the hassle of storing bullion or trading futures found an alternate solution in 2003: exchange-traded funds. These funds, which have surged in popularity, buy gold and issue shares that trade on the stock exchange. ETFs bought a record 734 metric tons of gold in the first half of 2020, according to the World Gold Council, taking overall holdings to 3,621 tons.
This buying offset a 46% slump in sales of jewellery, a common means of investing in gold in Asia. India and China led the decline, which the WGC attributed to shop closures, economic uncertainty and high prices.
Why are gold prices soaring?
The main reason is this yearâs precipitous drop in yields on U.S. Treasurys to levels below the expected pace of inflation. Unlike bonds or bank deposits, gold doesnât pay any income. As a result, owning gold means missing out on yields from other assets when interest rates are high. When real yields are negative, goldâs lack of yield becomes a strength.
The Federal Reserveâs March decision to slash interest rates to just above zero and buy hundreds of billions of dollars of bonds has pulled down yields in fixed-income markets, prompting investors to buy gold instead. Some money managers expect inflation to pick up once the economic crunch is over, which would act as a further drag on real yields if nominal rates donât rise.
Read also: Gold stocks have enjoyed record rally, but theyâve lost their lustre for foreign investors
Investors are also buying gold because they think it will hold its value if stocks take another tumble. Enthusiasts take this argument a step further, contending that gold is the ultimate insurance policy against a scenario in which the U.S. government defaults or kindles inflation to alleviate the burden of debt.
âGold is a haven,â said Rhona OâConnell, head of market analysis for Europe, the Middle East, Africa and Asia at StoneX Group. âIt doesnât have anyone elseâs political or financial risk associated with it.â
How does this gold price compare with previous bull runs?
Two other run-ups have taken place since President Nixon cut the link between gold and dollars in August 1971. The most dramatic spanned the rest of the 1970s, when inflation exacerbated by twin oil crises led the gold price in London to soar from $43 a troy ounce to a peak of $850 in early 1980.
âWeâre in World War Eight, if you believe the market,â a commodities broker named James Sinclair told the New York Times on January 21 of that year, the day prices crested.
Prices jumped again from 2008-2011, when interest rates fell because of aggressive stimulus measures by the Fed and a recession that was, at that point, the worst since the Great Depression. Worries that bond-buying by the Fed would lead to runaway inflation â which didnât transpire â also contributed to the advance
Will gold price keep rising?
It took three years after the start of the previous financial crisis for gold prices to peak, notes Edmund Moy, who was director of the U.S. Mint at the time.
âThey kept on going up until it was very clear that the U.S. economy would recover slowly and that there would not be inflation,â he said. âI think weâre at the very beginning of momentum for gold prices going up.â
âWhen things go crazy and the surety of everything is questioned, the two things everyone turns to are gold and silver.”
Gold prices tend to overshoot, according to Fergal OâConnor, an economist at University College Cork who has studied the marketâs history. Still, he expects them to fall back to a higher level than they were before the pandemic because institutional investors are adding to their gold holdings, removing a chunk of available supply. The return of jewellery demand in China and India could also boost prices.
The biggest deciding factor will be the direction of interest rates, adjusted for inflation, said Suki Cooper, an analyst at Standard Chartered. âItâs real yields that are really driving the flows into gold.â
Cashing in on rising gold price: Where does gold come from?
Gold ores are mined from rocks in underground and open pits all over the world. China has emerged as the biggest miner, digging up 420 metric tons in 2019, according to the U.S. Geological Survey. Other sources include Russia, Australia and the U.S.
Toxic cyanide solutions are used to dissolve gold, extracting it from crushed rocks, before miners partially refine the metal into impure bars known as doré. These are sold to specialist refiners, which transform doré into gold that has close to 100% purity with either gaseous chlorine or electrolysis.
Refiners play another crucial role: recycling.
Since gold is chemically inert and malleable, it lasts for thousands of years and can be endlessly refashioned. Around one-quarter of demand is met with recycled gold, according to the World Gold Council. Of that, 90% comes from jewellery. Recycling has picked up as people have sold bullion to cash in on rising prices.
Insights on gold price: Is gold a commodity or a currency?
Both. Gold is a commodity in that it derives its value, in part, from its use in products like jewellery. Banks that are active in the physical market trade gold on their commodities books, and the futures market in the U.S. is regulated by the Commodity Futures Trading Commission. Gold is treated like any other commodity on banksâ balance sheets under the Basel III regulatory guidelines, designed to avoid a repeat of the 2008-9 financial crisis.
Gold is also a currency. For millennia, the metal has functioned as a store of value, unit of account and medium of exchange.
âThe Egyptians were casting gold bars as money as early as 4000 B.C., each bar stamped with the name of the Pharaoh Menes,â the financial historian Peter Bernstein writes in âThe Power of Gold: The History of an Obsession.â
Bullion played a foundational role in the monetary system from 1717, when Isaac Newton, master of Englandâs Mint, established a price ratio between gold and silver, to 1971, when President Nixon ended the convertibility of dollars into the precious metal.
Though gold stopped underpinning exchange rates after the âNixon Shock,â the metal still plays a part in currency markets. Central banks in emerging markets have, for instance, boosted their gold holdings in recent years in an attempt to diversify their reserves away from dollars.
âIt is more a currency than a commodity,â said Dr. OâConnor. âEverything else, to one degree or another, gets used up and doesnât come back into the market. Gold just stays there.â
Write to Joe Wallace at [email protected]