Gold – time to shine again?
Towards the end of last summer gold hit a record intra-day high of $2,075 per ounce. Finally, the yellow metal had managed a significant break above its old record of around $1,900 from back in September 2011, nearly 20 years ago. Last year’s rally came on the back of expectations of higher inflation as governments around the world announced stimulus measures to address the economic devastation wrought by the coronavirus pandemic. This was coupled with record low interest rates and substantial bond purchase programmes maintained by developed world central banks. Added to this was the decline in the US dollar. The Dollar Index, which measures the greenback against a weighted basket of currencies, fell around 12% between March and August last year before levelling out. Yet despite a seemingly benign situation as far as the dollar is concerned, gold has fallen around 18% from its record high, currently languishing just a touch above $1,700 per ounce. On top of this, the Biden administration has pushed through its American Rescue Plan, further fiscal stimulus of $1.9 trillion, and is now working on a second package aimed at climate change, infrastructure renewal, education, and health worth between $2 and $4 trillion. Interest rates are still at rock-bottom levels and inflation is still below target. But gold is back down at levels not seen since June last year.
What impacts the price of gold?
The common rule of thumb is that the price of gold (in dollars) moves inversely to the US dollar. The thinking behind this is that when the dollar goes up, gold becomes more expensive to buy for non-dollar holders. While simple and neat, it isn’t always true. There have been plenty of times when the dollar and gold have moved in tandem. Likewise, it’s often said that gold is inversely correlated to equities. But a quick glance of the charts from March 2020, or the Financial Crisis of 2008/9 will show you that doesn’t always hold either. Two other widely accepted maxims are that gold always does well during periods of high, or rising, inflation, and does badly when interest rates increase. The explanation for the former is that investors divest themselves of cash and seek out hard assets, like gold, to protect themselves from currency depreciation. As to the latter, gold generally doesn’t pay interest, unless you’re a bullion bank, so loses its appeal when other financial instruments do. There is some truth in both these propositions but really, it’s the combination that matters.
Gold and inflation
When investors see signs that inflation is taking hold, they look for ways to protect themselves from it. But they also expect central banks to raise interest rates to prevent prices spiralling out of control. Gold is an attractive hedge against rising prices, although not when interest rates are going up too. But it is real interest rates that matter. That is, interest rates adjusted for inflation. Investors often turn to gold when inflation kicks in, but central banks hold off from raising rates in response.
Now we’re seeing evidence of a rise in inflation in many commodities, such as copper and nickel, and agricultural produce too. Much of this hasn’t been picked up by the major inflation indices such as the Consumer Price Index (CPI) or the US Federal Reserve’s preferred inflation measure, the Personal Consumption Expenditures Price Index (PCE). The last PCE update showed a year-on-year inflation increase of 1.5%, still some way below the Federal Reserve’s official 2% target rate. Not only that but the Fed has let it be known that it’s happy to let inflation rise above this target level for some time before it will start to wind down its bond buying programme, let alone raise its key Fed Funds interest rate.
What does this mean for gold?
With gold it’s real rates that matter: bond yields minus inflation. And it’s possible that we may be approaching a more positive environment for the yellow metal. We’ve lived with a zero, or in some countries even negative interest rates for years now. At the same time, inflation pressures have been subdued, at least when using standard measures. This is despite the ongoing bond buying packages engaged in by the world’s major central banks since the height of the financial crisis in 2008/9. But after years of inaction, now governments are responding to the economic slump caused by the measures taken during the coronavirus pandemic. Old rules concerning the running of budget deficits and the size of national debt in relation to economic growth are being jettisoned.
So, with a growing perception that inflation is picking up, and central bankers making it clear they’re unwilling to tighten monetary policy, there could be a change in sentiment towards gold. Well possibly. It’s now arguable that gold is no longer the ‘go-to safe-haven’ that it once was thanks to the growing popularity of an alternative. Bitcoin holds many of the qualities of gold, including limited availability. Both gold and Bitcoin must be ‘mined’. But for many investors the cryptocurrency has advantages in that it is easier to use as a medium of exchange. Sure, there are still issues concerning take-up and security which mean gold may remain popular as a safe asset. But the next bout of serious inflation will show us if gold has finally been usurped as the ultimate haven for investors, or if Bitcoin will have to wait a bit longer for its day in the sun.