Is Gold Still a Safe-Haven Asset?

The onset of 2020 saw significant financial market turmoil and heightened asset price volatility as the COVID-19 pandemic raged globally. The same rings true for gold. The spot gold price in one week alone plunged over 15% in mid-March. As a result, it was questioned whether gold’s role as a diversifier still held as gold’s safe-haven status was seemingly lost.

So, Is Gold Still A Safe-Haven Asset?

On the face of it, the drastic volatility in the gold price at the beginning of the pandemic looked quite similar to what we saw in the 2008 global financial crisis. However, the root causes of the two are different. Theoretically speaking, there are a host of factors that affect the gold price and the role each plays differs. The significant gold price volatility this year was not as a result of traditional fundamental or geopolitical factors, but mainly driven by the sudden disruption of economic activities together with the macroeconomic policies launched against the gloomy growth outlook in times of market distress.

In mid-March, gold appeared to have lost its safe-haven status as the gold price tumbled due to the combined effects of a number of factors, including the global stock market rout, the highly synchronised price movement between gold and commodities, the magnified role of a strong dollar and the oil price crash. However, in the long run, gold is still a sought-after safe-haven asset and will continue to shine as a portfolio diversifier given the massive and unprecedented monetary and fiscal stimulus measures were launched by central banks and governments worldwide to combat the economic damage generated by the virus.

Drivers Behind The Heightened Gold Price Volatility

At the end of March, the gold price nosedived to $1,450.98/oz from its Q1 peak of $1,702.56/oz, a steep drop of 14.78%, which was followed by a rapid rally. As illustrated in Chart 1, gold continued to push higher, hitting $1,689/ oz on 10 April and then $1,786.02/oz at the end of June, before reaching an eight-year peak, up 17.36% YOY in the first half of 2020.

So what led to the huge price volatility in gold this time round?

1. The plunge in financial assets across the board in the US and Europe due to COVID-19 Since the COVID-19

outbreak, the total number of confirmed cases worldwide reported to WHO has exceeded 12.76 million (as of 30 June). Most of the countries responded to the health crisis by introducing lockdown measures, which pushed the world economy into a temporary lockdown and the medium to long-term global growth outlook into negative territory.

As we all know, human capital is the most dynamic factor in driving productivity. Once the health or life of humanity is under threat, the demand for work and wealth suddenly becomes awfully subdued. So, it is inevitable that once COVID-19 put human capital in jeopardy, it wreaked havoc on the real economy, which manifested in business shutdowns, market shrinkage and a free-fall in trade activities from the transportation, hotel, catering, wholesale, culture, sports and entertainment sectors.

The crisis in the real economy, with its knock-on effect on the whole financial market, got amplified and, in turn, commodity, bond, equity and gold markets became highly volatile. It then moved rapidly onto financial institutions such as asset management companies, insurance companies and banks, snowballing into larger crises. In other words, the colossal ‘top-down’ damage from COVID-19 to the real economy set major systemic risks off in the global financial markets, which in turn imposed more acute and sweeping repercussions than the ‘bubbles’ in previous financial crises. Chart 2 below illustrates this point. Since COVID-19 hit advanced economies in March and began spreading rapidly, there have been growing concerns about an economic downturn and a liquidity squeeze. Consequently, the VIX Index saw a surge to an all-time high of 82.69 on 16 March.

During the same period, the US equity market saw four circuit breakers triggered on 9, 12, 16 and 18 March. The Fed responded by aggressively cutting rates to near zero, and introducing a new $700 billion QE programme and a combination of policy toolkits to inject liquidity directly to consumers, businesses, funds and banks. This was achieved through expanding the Consumer Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), the Money Market Mutual Fund Liquidity Facility (MMLF) and ‘unlimited’ QE bond buying, establishing the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF), etc. Despite all these initiatives, the US equity market was still subject to heightened swings, further proof of market-wide panic and liquidity constraints. Faced with this decline and significant volatility across global equity markets, some investors had to sell liquid assets such as gold to cover their losses and margin calls. And in so doing, money flowed out from gold market.

Worse still, the virus-induced ‘all-out crisis’ plunged the world economy into a downward spiral, depleting liquidity in the financial markets and bringing a precipitous drop across the asset classes, including equity, crude oil, gold and bonds. Rising uncertainty and risks, together with deleveraging, led to the trampling effect and the plummeting of financial assets. Even gold was not immune to this sell-off across the board and its safehaven status remained dormant amid the early financial turbulence.

2. Price actions for gold and commodities moved in lockstep as gold is widely included in financial asset indices

Financial products such as the Commodity Research Bureau (CRB) Index futures, one of the most widely traded contracts worldwide, covers 19 commodities, including crude oil and gold (in this case, gold’s role as monetary value becomes vague). So, if commodity prices tank, especially when risk-off tone returns, investors tend to sell off CRB Index contracts. Therefore, gold was indiscriminately liquidated along with other assets as all commodities were included and bonded in the index in equal proportion.

Likewise, gold has also been widely added to investment portfolios, meaning that when the financial markets see a rise in volatility, gold tends to move in lockstep with it. This might well explain why gold lost its safe-haven status when risks started to surge in the international financial markets. However, the correlation between gold and other commodities is not organic in that it is designed and made by humans to optimise asset allocation. After all, gold, unlike other commodities and common financial assets, will usually recover its safe-haven status when the shock of a liquidity crisis gradually eases.

3. The magnified role of the US dollar in the gold price

The US Dollar Index is a major factor affecting the gold price. Despite the inverse correlation that the index has with the gold price in the long run, the effect of such a correlation gets greatly magnified when financial liquidity is in extremely short supply. A case in point is when the US Dollar Index experienced a temporary drop in late February as a result of the COVID-19 contagion and the US stock market rout. On 9 March, the US equity market hit its two-year low, triggering the first circuit breaker this year. As market liquidity started to squeeze, the US Dollar Index soared to 103.01 on 20 March, a new three-year high. Contrary to the US dollar, the gold price lost its upward momentum on 9 March and started to dive down. With this in mind, we can see that the inverse correlation between gold and the dollar index got greatly magnified.

With looming risks, market panic crept in as investors were faced with significant uncertainties and extreme fluctuations. At this point, the US dollar, a benchmark for global wealth, was undoubtedly the hedge of choice against market risks, and that was the rationale behind the sell-everything-for-the-greenback response, even though the Fed unleashed two rounds of unconventional rate cuts in March.

The highly leveraged US equity market faced a situation of forced liquidation risks and liquidity crisis when the dollar plunged. Though the Fed injected more cash into the market via banks, the liquidity found it hard to make its way into the equity market as US banks are subject to the Volker Rules, which generally prohibit banking entities from engaging in proprietary trading or owning, investing in or sponsoring hedge funds or private equity funds. On top of that, highfrequency trading and financial derivatives exacerbated the liquidity crunch because of the liquidation of assets in dollar terms in extreme market conditions. Then, cash became king again across the financial markets. Even though the Fed cut interest rates to near zero and launched QE bond buying, the liquidity crunch did not ease. Normally, the US Dollar Index dips following rate cuts, but it surged surprisingly this time, which indicates the magnified role of the greenback in financial markets.

4. Oil price crash weighed on gold

Amid the initial phase of the COVID-19 outbreak in China, there were concerns over China’s economic fallouts from the virus, which aggravated the imbalance between supply and demand in the global oil market and sent the oil price in a downward spiral.

On 22 February, the virus started to hit other countries and worries about the epidemic intensified as the oil price dipped at a faster pace. On 4 March, Russia rejected the OPEC+ backed additional oil cuts. On 7 March, Saudi Arabia announced its decision to sell oil at a sharply discounted price and increase its production to well above 10 million barrels a day, which it then increased to 11 million barrels a day in April. Subsequently, other OPEC members followed suit and joined the oil price war. On 9 March, the oil price took another dive, with the WTI crude oil price nearly back below $20 mark at $20.06 per barrel from its peak $65.65 per barrel, down approximately 70%. In this sense, the oil price crash weakened further the already fragile financial markets.

Low oil prices also pounded the US shale oil sector, with the majority of US shale drillers and producers bearing the brunt and being forced into debt crisis, given that the break-even cost on average is above $45 dollars a barrel. In the meantime, the shares across the sector started to collapse, with the industry tycoon Chesapeake Energy down by 75% in less than a year. In this sense, panic in the equity market and the liquidity crunch were clearly intensified.