The Age of Gold

Gold prices reached a historical apex and many investors and analysts are full of joy, hoping that this might signal the end of the crisis triggered by the COVID outbreak. But, is it reasonable to believe that a high Gold price is a positive signal?

The answer is definitely no. Investors do not buy Gold because they have excess of cash or because they want to diversify their portfolios. They buy the yellow metal because it is perceived as a safe harbour. When everything will go wrong and most assets may become worthless, holding gold will be a guarantee of having some value. The fear about the day after tomorrow fuels investors’ appetite for Gold and for other safe-harbour assets like Bitcoin. The main dilemma is whether one should buy physical Gold or futures?

Let us remember that the richest person who ever lived, the Malian king Mansa Musa, had an estimated net worth of over 400 billion USD, most of it invested in physical gold. But in the current environment, not only high net worth investors are long on gold. The higher the fear of regular investors or even of those who want to have some form of savings, the bigger is the likelihood to buy physical Gold. Therefore, the premium of physical Gold compared to futures may experience a positive drift in the long-run.

The price of Gold is nothing else than a fair estimate of the price of fear in the market. Interestingly, the volatility index has a relative low level, indicating that the options traders do not apprehend unrest in the market. But how reliable is this view?

Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.
Warren Buffett, American investor

Market overview

The Dow Jones moved strongly into positive territory and found support at 27,000. The leading US equity index is at the same level it was in November last year. The only difference is that the US economy contracted by 9.5% in the second quarter compared to the same period of the last year. So, how reliable are the market prices? If the market prices are distorted what is the true value of money? While many are pleased that they do not see a big dip in the stock market, bigger problems could rise in the long-term.  If valuations do not make sense, what is the meaning to value something in fiat currency?

Macro:

Digital countries are more resilient to crisis

Macro-economic data from the second quarter starts to be available and as expected most countries exhibit a massive GDP contraction in the second quarter amid the COVID-triggered lockdown. Spain, Portugal and France suffered the most due to their prolonged economic shutdown. In Europe, Nordic and Baltic countries were less impacted. Lithuania’s GDP contracted with only 3.8% in the second quarter compared to the similar period of the last year. In Asia, South Korea had a relatively small contraction while China shows a 3% growth. The United States did better than the European Union, but their early lockdown exit led to a bigger impact of the pandemic, with a higher number of casualties.

The bottom line is that countries that showed resilience like the Baltic countries or South Korea are also the countries where the digital economy has a bigger share of the total domestic product. Thus, these countries were in a better shape to get over a prolonged lockdown.

Focus:

Volatility

After reaching a climax in mid-March, the S&P 500 volatility index moved asymptotically towards the level it had before the pandemic outbreak. After a local spike in mid-June, the volatility seems to retreat towards more acceptable levels. Does it mean that one should sell out-of-the-money options? Quite the contrary!

A unique phenomenon seems to occur in the volatility pattern. Volatility displays not only a stochastic behaviour but also follows a regime-switching dynamic. Therefore, the market has moments of calm, characterized by low volatility, especially when there are not too many important news. But, it has also moments of clarity when the accumulation of non-aggregated information is included in the price dynamic, resulting in a volatility explosion.

One may debate that currently, there is plenty of liquidity injected in the market. And we know from the 1970s that liquidity is a guarantee for market efficiency. But is the market efficient right now?

Let us not forget that for a market to be efficient, the actors should aim to maximize their profits. But, when liquidity has a negative price, there is no incentive to maximize profits. Thus, the significant contraction of the US GDP seems not to hinder the stock market nor the volatility. Lack of efficiency is often associated with skewness and kurtosis in market returns. So be aware of any jump that may come!

Market outlook

Markets ended the week into positive territory.  The Gold ounce reached its historical maxima. Even if we may witness some technical corrections, the Gold ounce is expected to move north.

We argued that Bitcoin needs a more reliable price signal and investors finally realized that Bitcoin’s value is more than 10,000 USD. The increasing fear amongst the retail investors and the need for new sources of alpha for institutional will bring positive momentum in the cryptocurrency arena. There are strong fundamentals for a Bitcoin trading above 12,000 USD.

The Dow Jones moved in a spectacular rally above 27,000, while NASDAQ found support at 11,000. NASDAQ should continue its quest for positive momentum until September. The future of Dow Jones could be much more hectic, and towards November we may witness more volatility.  

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