While it’s tempting to think that gold represents an objective, unswayable measure of wealth, particularly given the precious metal’s role as an investment throughout the course of history, it is not. Gold’s value rises and falls just like any other investment. While gold will almost certainly never gain nor lose relative value as quickly as penny stocks and dot-com initial public offerings, gold’s price movements can still convey information.
That information reflects investor confidence, the probability of stock price and currency increases, and more. A wise investor is one who recognises gold’s place in the market, without attaching too much or too little significance to it.
The new gold rush
August this year saw the start of a new gold rush. Suddenly, the precious metal had regained its long-lost glitter, jumping to over USD2,000 an ounce during the first full week of August – its highest inflation-adjusted level in a decade. That new peak roughly matched its all-time record in 1980 when the Hunt brothers of Texas notoriously cornered the silver market and gold joined the ride. Then gold collapsed from what everyone in retrospect recognises as delirious heights. Now, the goldbugs are claiming that it’s a safe investment, while history warns that there could be a rerun of 1980. Who’s right?
Gold is insurance against ginormous fiscal deficits and inflation
Gold fans argue that the precious metal’s classic store of value provides the best insurance against the threat of rampant inflation raised by the US government’s unprecedented fiscal stimulus and the Fed’s money-creation binge. Ruchir Sharma, chief global strategist for Morgan Stanley, recently expressed the widespread view that gold’s resurgence has legs, because stocking bullion furnishes a safe haven in these dangerous times. On 8 August, as its price hovered over USD2,000, Sharma wrote in a New York Times editorial that “Gold appears relatively cheap,” adding that “unless a vaccine emerges quickly, central banks stop printing money frantically, and real interest rates start rising again, it’s difficult not to be a goldbug right now.”
If gold’s advocates are right, the metal should have a long history of first, predicting when inflation is about to take off, and second, providing protection when it happens, in periods when consumer and producer prices are rapidly rising. Over many decades and cycles, gold has failed on both counts. In fact, fear of looming inflation probably isn’t the main motive behind today’s mania. The puny yields on 10- and 30-year Treasuries are forecasting the opposite scenario of prices rising at an unusually slow pace in the years ahead. Even if Treasuries way underestimate the risks of heavy inflation, and that’s highly possible, gold has reached such excessive highs that it’s unlikely to keep rising substantially from here, which is what’s needed to keep you even with a galloping consumer price index (CPI). Catching gold fever is far more likely to saddle you with a big loss.
Economists Claude B. Erb, of the National Bureau of Economic Research, and Campbell Harvey, a professor at Duke University’s Fuqua School of Business, have studied the price of gold in relation to several factors. It turns out that gold doesn’t correlate well to inflation. That is, when inflation rises, it doesn’t mean that gold is necessarily a good bet.
In their paper titled The Golden Dilemma, Erb and Harvey note that gold has positive price elasticity. That essentially means that, as more people buy gold, the price goes up, in line with demand. It also means there aren’t any underlying ‘fundamentals’ to the price of gold. If investors start flocking to gold, the price rises no matter what shape the economy is or what monetary policy might be.
That doesn’t mean that gold prices are completely random or the result of herd behaviour. Some forces affect the supply of gold in the wider market, and gold is a worldwide commodity market, like oil or coffee.
When and why do gold prices plummet?
- While gold is often seen as a safehaven investment and store of value, it is also a produced commodity and subject to those same economic forces.
- When gold miners produce an excess of gold relative to demand, the price will experience downward pressure due to the laws of economics.
- Speculators that accumulate or let go of gold in the market can create temporary imbalances that lead to rapid price changes.
2020 Gold price forecast, trends, and 5-year predictions
There are many factors, of course, that could impact the gold price in both the short and long term. According to Jeff Clark, Senior Analyst at GoldSilver, the primary factors that will impact the price of gold this year and into the future are:
- The US dollar
- Investment demand
- Central bank buying
- Trading volumes on the COMEX
- Technical indicators
- New mine supply
- Coming economic and monetary factors
The US Dollar and gold
Gold and the US dollar are inversely correlated about two-thirds of the time (when one rises the other tends to fall, and vice versa). While global investors do tend to move into the US dollar during periods of uncertainty, that move was muted last year despite, for example, the trade war with China. They instead moved into gold.
Central bank buying gold
According to Peter Hug, director of global trading at Kitco, the big market movers of gold prices are often central banks. In times when foreign exchange reserves are large, and the economy is humming along, a central bank will want to reduce the amount of gold it holds. That’s because the gold is a dead asset – unlike bonds or even money in a deposit account, it generates no return.
The problem for central banks is that this is precisely when the other investors out there aren’t that interested in gold. Thus, a central bank is always on the wrong side of the trade, even though selling that gold is precisely what the bank is supposed to do. As a result, the price of gold falls.
Central banks have tried to manage their gold sales in a cartel-like fashion, to avoid disrupting the market too much. Something called the Washington Agreement essentially states that the banks won’t sell more than 400 metric tons in a year. It’s not binding, as it’s not a treaty; rather, it’s more of a gentleman’s agreement – but one that is in the interests of central banks, since unloading too much gold on the market at once would negatively affect their portfolios.
Gold in a portfolio- what are some of the considerations?
Hug says a good question for investors is what the rationale for buying gold is. As a hedge against inflation, it doesn’t work well. However, seen as one piece of a larger portfolio, gold is a reasonable diversifier. It’s simply important to recognise what it can and cannot do.
If you’re looking at gold prices, it’s probably a good idea to look at how well the economies of certain countries are doing. As economic conditions worsen, the price will (usually) rise. Gold is a commodity that isn’t tied to anything else; in small doses, it makes a good diversifying element for a portfolio. And one good thing about gold: it does retain value. The conclusion Erb and Harvey have arrived at is that the purchasing power of gold has stayed quite constant and largely unrelated to its current price.
