Gold Leads as Safe Haven, but Beware of Consensus Trades


A note from Bank of America with a $3,000 price target gave new impetus on Tuesday



A New Paradigm?

 

Since the start of the year, gold has been the only asset to continue to trade near all-time highs. Supported by relentless demand for a safe asset, the price of gold is currently above $1,700 an ounce, just about $200 lower than a record $1,921 it reached in 2011.

 

The market sentiment is overwhelmingly positive for a variety of factors, which we will detail below.

 

Over the past couple of years, discussion about the safest assets to invest in has been vibrant. Some argue that the future lies with tech stocks, as the value of physical goods takes a hit in an ever-increasing digitalization of the economic relationships between people. This camp claims that gold has no room in the digital era, and even go as far as to declare that Bitcoin is the digital gold.

 

This thesis fell flat in February and March this year, as traders sold off Bitcoin and cryptocurrencies in tandem with the stock market.

 

Traditionally, when stock markets sell-off, big institutional investors shift money into bonds to adjust their risk exposure. This long-term relationship between stocks and bonds broke down in the middle of March, as both asset classes posted declines at the same time. As the Federal Reserve stepped in to buy corporate bonds and yields stabilized, some investors began to look elsewhere for safety.

 

Demand for gold returned with a bang, just as the Federal Reserve spent $1.1 trillion on buying government and corporate bonds. Many big asset management funds chose to offload risk to the Fed, by selling bond holdings to the central bank, instead of keeping them to maturity. With more than $500 billion spent so far in April, the Fed has effectively nationalized the bond market and prompted investors to rethink their strategies.

 

Many prominent asset managers piled into gold as an alternative safe investment, which some believe is guaranteed to retain its value. In a report titled “The Fed can’t print gold”, Bank of America said that as the world’s biggest central bank keeps printing new money to buy more corporate and government bonds, the value of the yellow metal could skyrocket.

 

With all “gold bugs” vindicated and with an overwhelming consensus among market participants that gold has nowhere to go but up, we are faced with a potential new paradigm.

 

Charting a Bubble

 

A chart developed by Canadian scholar Jean-Paul Rodrigue is often used in turbulent times across different financial markets. His “phases of bubble” diagram, you can see below, became very popular during the global financial crisis of 2008, and around the Bitcoin bubble was forming in 2017.

Bubble Chart

In Rodrigue’s view, every asset bubble consists of four phases: the stealth phase, the awareness phase, the mania phase, and the blow-off phase. During the stealth phase, so-called “smart money” investors are starting to accumulate the asset. After prices take off, the bubble enters its awareness phase, where institutional investors become aware of the asset, and begin to buy it aggressively.

 

Enter the mania phase, where the public becomes aware of the asset and discussion about it enters the mainstream media. Ask yourself how many times you have seen gold bugs talking on TV, YouTube, and Twitter over the past several years, saying how important it is for every investor to exchange between 5% and 10% of their assets in gold.

 

Eventually, once the public enters the bubble, we enter the blow-off phase where gravity takes hold, and early investors unload their holdings to the.. you guessed it - most frequently the retail traders.

 

A 30-year look at gold

 

The traditional narrative that is widely being advocated by the proponents of gold is that it is the ultimate safe-haven asset. It has worked as a store of value since the beginning of civilization and it will work as one indefinitely. While many of you are in the camp that believes this, I will allow myself to question the value of gold by examining its 30-year chart below.

Gold Chart 30 years


You can apply here Jean-Paul Rodrigue’s theory that we discussed earlier and decide for yourself. Whether gold has any value in the digital era remains an open question. One thing is sure, the digitalization of the global economy is here to stay, whether we like it or not.

 

The purpose of this article is not to give investment advice. My goal instead is to question some widely accepted narratives and remind you that every asset can trade up or down. Ultimately, it is up to you to weigh the risk factors, and determine where you think the next stop is for gold.



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