The new coronavirus affected the world’s economies on an unprecedented scale. Developed, developing, emerging, and frontier markets alike barely cope with the challenges posed by the outbreak.
The more we go without a clear solution to the health problem, the deeper the economic recession. In economic terms, the first sign of a declining economic growth is called contraction. An economy that keeps contracting with no meaningful bounce enters recession. Acute recession without a steady recovery leads to depression.
Four months into the COVID-19 health crisis, there are more countries in recession this year simultaneously than during the world wars or the great depression. The world’s economy always had some parts of it in a different stage of the business cycle – not this time.
The Longer the Recession, the Stronger the Bid for Gold
Yesterday the price of gold broke above $1800. Already there are voices forecasting $2500 and even $3000 sooner rather than later. Are such values out of context? Certainly not.
Gold has long been viewed as the one form of money that preserved wealth throughout millennia. Even after the 1970s, when the United States dropped the USD convertibility to gold, the yellow metal kept its aura.
A quick comparison between the main fiat currencies and the price of gold since 1900 reveals why investors keep adding gold to their portfolio throughout time. The demand for gold did not affect its buying power – one cannot print gold as central banks can print fiat currencies.
What is interesting enough is that the main beneficiaries of the rise in the price of gold are – your guessed – central banks. In the last two decades, world central bank gold holdings increased significantly. Why would anyone buy gold if gold is not money and if it has no role in the current financial system?
The answer comes from the old law of demand and supply. If anything has value, investors (central banks included) will bid for it. For as long as the perceived value exists, there will always be a bidder at lower prices.
Nowadays, central banks acquire all kinds of junk assets (e.g., non-performing loans, junk bonds from the dubious corporations, etc.), in an attempt to provide liquidity (in fiat currencies) to the economies. As a result, their balance sheets rose exponentially.
We should not be surprised at all to see central banks holding gold worth much more than their purchasing price – we should all be glad, as the higher the price of gold, the more ammunition central banks have to alleviate the coronavirus economic shock.