gold stocks to flourish

Over the three months between the 7th of May and the 7th of August 2019, the S&P//ASX200 Australian gold miners index (XGD.ASX) has risen more than 55 percent. During that same time, physical gold has risen 16.57 percent, and Australian dollar physical gold has risen around 36 percent.

What has caused strong rise in gold and Aussie gold stocks? And will it continue?

  1. Australian dollar weakness

The price of gold in Australian dollars has risen far in excess of the US dollar gold price, this is due to a large reduction in the value of an Australian dollar vs a US dollar. Since gold is traded in US dollars, when a US dollar gains in value relative to the Australian dollar (a USD is worth more Australian dollars), gold is also worth more Australian dollars.

With the Reserve Bank of Australia (RBA) cash rate heading to a record low 1.0% during the period the Australian dollar has weakened, increasing the value of gold relative to an Australian dollar. We would expect the RBA to continue to cut rates and we would expect Australian interest rates to remain below those in the US; we would therefore expect the Australian dollar to remain weak – and for this to support or increase the Australian dollar price of gold.

  1. Global economic uncertainty

Gold is traditionally seen as a safe store of value; as businesses fail and profits drop, gold will still be gold. Therefore, when there is uncertainty around the world and investors become less confident in other risk assets – you often see an appreciation in gold prices.

The current period of uncertainty around the US-China trade war, expectations of declining economic growth, and the US yield curve inversion has increased uncertainty in global asset markets. This uncertainty is, and has always been, good for the price of gold. Whether this uncertainty continues is hard to say, but it is definitely worth noting that most economic growth forecasts in the developed world for the next few years predict a further drop in growth.

  1. Low and declining global interest rates

Interest rates have dropped a half a percent in Australia in the past three months and a quarter of a percent in the US. Interest rates in Europe and Japan remain extremely low. The lower that interest rates go, the lower the return an investor is willing to receive on an asset. An example of this is if government bonds are yielding 4 percent, an investor would not be happy with a 4 percent return on a riskier asset. However, if government bonds are yielding 1 percent, that 4 percent may be more acceptable.

Therefore, as interest rates have declined, it has made it more attractive to hold gold (which has no inherent return, other than price growth).

Interest rates in the developed world are unlikely to rise significantly in the near future and this is a positive thing for gold prices. Low interest rates are therefore likely to support gold prices for a while yet.

End note: Australian gold stocks have had a meteoric rise over the past three months, far outpacing the rise in Australian dollar gold. I would not be surprised therefore to see some pullback in ASX listed gold stocks in the short term. However, over a longer-term period, the factors that have led to the rise in the gold price this year are likely to continue for a while yet.