Could the Golden Baby be Thrown Out With the Bathwater as COVID-19 Impacts the World?
In our last article (here) we warned of the risk of market optimism, i.e. investors underestimating the severity of the virus, and that general equities were bound for corrections. The gold price has mostly been performing in line with our expectations, rising by close to 5 percent in just 20 days, though it may be losing steam in more recent times. In this article, we speculate about whether COVID-19 could create severe damage to the financial system similar to, or even worse than, that of the 2008 Global Financial Crisis, and what impact this might have on the gold price.
We assumed that COVID-19 would have as big an impact as SARS on the financial system. Therefore, we used the gold price performance during the SARS period as a rough guide to how the gold price may look during the current time:
Using the closing price of gold on the last day in 2019 as the starting point (1,517/oz), a 10 percent increase indicates a gold price of USD 1,668.7/oz, and a 19 percent increase translates to USD 1,805.2/oz.
However, there are several points that lead us to believe the impact of COVID-19 may be more severe than that of SARS:
- Some of the infected do not show any symptoms yet may still be contagious. This vastly increased the spread of the virus
- 14 days of quarantine may not be enough – there are cases to suggest that the incubation period could last well over 14 days.
- Those who are cured may continue to be contagious. There are reports from around the world of people who have seemingly fully recovered then continuing to test positive.
Hit on the Financial Market
| Return | S&P 500 | FTSE 100 | Nikkei 225 | Gold Spot | .XAU (Gold Equities Index) |
| 13-27 Feb | -11.75% | -8.27% | -7.34% | +3.28% | -2.14% |
Now that the virus seems to be spreading overseas, the market has begun to take notice. The S&P 500 lost 11.75 percent between 13–27 February, wiping out all the gains it had this year. The FTSE 100 and Nikkei 225 have lost 8.3 percent and 7.3 percent respectively within the same time span.
In our last report in early February, we suggested that, as the financial market was underestimating the negative impact COVID-19 could unleash, gold’s status as a safe bet would see it become a beneficiary. Indeed, the gold price already ramped up 4.6 percent between 7-27 February, although it has been losing steam lately. The gold price has attempted to break above USD 1,650/oz four times, but so far has failed to sustain this price level.
Despite the resilience of the gold price, prices of both silver and platinum, which historically have high correlation with gold, were down by 1.9 percent and 6.0 percent respectively. This time around, it appears that the market has decided to treat silver and platinum as industrial metals rather than monetary metals. Palladium is the only exception, with the price rising by over 24.9 percent in the first 27 days of February and then starting to freefall on the final day of the month.
Warning Sign: XAU Index Lost 7 Percent On In One Trading Day
Despite the plunge of the general equities market, the gold mining equities sector has been relatively strong thanks to the support of the gold price. During the same period of 13-27 February, the gold mining equities index lost just 2 percent, with all the damage done on the last day. This saw the index losing 7.0 percent in a single trading day. Such a sharp fall in gold equities in one day is concerning, especially as the gold price was relatively stable. It also signalled that there is panic in the market as well as increasing demand for liquidity. Both of these factors could possibly drive the gold price lower due to market capitulation.
To the financial markets, gold is not the ultimate safe haven; cash is. This is due to the large size of the pool and massive liquidity. Therefore, when the market panics, the gold price falls along with the equities market as traders scramble for cash – even though, in theory, gold should perform well. Traders have to sell winners (gold in this case) because they have suffered from margin calls in other positions, or have simply taken profits to compensate the losses realised in other positions. For the potential downside risk in gold over the short term we can examine the performance of gold during the initial stage of the Global Financial Crisis in 2008:
The gold price essentially lost 35 percent from its short-term peak at USD 1,038/oz (17 March 2008) as the market panicked and bottomed at USD 733/oz in October. This consolidation took seven months to complete, followed by a strong rebound in price that separated itself from the continuing deterioration of the equities market.
We are not suggesting the gold price will see a heavy consolidation that will take another seven months, but a lot will depend on how the virus situation evolves.
Eikon COVID-19 Case Tracker
Therefore, while China’s ability to combat COVID-19 remains important, one needs to closely monitor the progress in other countries as well. Subscribers can follow the latest developments through the Coronavirus App on Eikon and can use the case tracker to keep track on how widely spread the COVID-19 is on a global scale. Another important country that needs to be monitored is the United States:
The number of cases in the United States is rising like a straight line (though the base is still low). No wonder the market has the jitters. If the virus spreads in the US while the market begins to see a contained situation outside of the country, the dollar could head even lower.
Two other important countries to examine are Singapore and Thailand.
Keeping track of the number of cases in these two countries is important because there is hope that, like the SARS virus, the cases of COVID-19 could fall sharply when the weather starts to warm up. However, as the number of actual cases in Singapore and Thailand are still rising, hot weather may only be able to limit the activity of the virus, not eliminate it, as it did with SARS.
Conclusion
During a market capitulation, throwing the baby out with bath water is common as traders panic and liquidity tightens. During the SARS period, the price of gold retreated from USD 388.5/oz to USD 318.75/oz (an 18 percent decline) in slightly more than two months followed by a strong rebound. Another risk working against the gold price is the decreased business activity in China as demand for gold has dried up and the Chinese gold price is currently trading at a discount to the LBMA gold price – and the discount has been widening. Judging by the historical gold price performance during the SARS period as well as the Global Financial Crisis, the current correction in the gold price may take months to complete followed by another leg up.
For commentary on how the Federal Reserve cut and it’s impact on our expectations, please our related article here: https://www.theassay.com/articles/federal-reserves-impact-on-gold-and-markets/
Group email: metals_research@refinitiv.com
