Gold Looks Like Neither Inflation Hedge Nor Safe Haven

For an asset often touted as some ultimate “safe haven” or “inflation hedge”, gold is having a difficult year.

If the metal really is what so many of its adherents believe it to be, then these should be some of the best days it has seen for years. After all, inflation has re-awakened across the globe. And that after decades of such obliging docility that a whole trading generation won’t have encountered price rises of current magnitude in their lives. Inured to a world in which even 2% inflation targets often proved elusive, 2022 has provided hard lessons.

And yet gold’s downtrend remains very much in place.

You don’t have to look very far to see need for a haven asset either. Russia’s invasion of Ukraine has crippled a European economy still utterly reliant on Putin’s regime for its energy needs. Tensions between China and the US threaten the last thirty years of largely peaceful globalization, to the point where many commentators are prepared to call it over. Covid has of course played its baleful part too, stunting global growth and, again, forcing a rethink of supply chains. Resilience is now prioritized where once price held sway. China’s neighbours increasingly eye its ambitions toward Taiwan with concern. Military budgets are rising across the region.

And still gold continues to weaken.

In truth the metal has spent much of the time since March behaving rather more like a classic ‘risk asset’ than any sort of haven.


Gold price chart – prepared using TradingView

Stock markets and gold have been falling more or less together since March, which looks counterintuitive if the latter really is any sort of effective haven or inflation hedge.

Clearly, as can be seen on the chart above, prices do rise when disaster strikes or inflation rises. But it’s also clear that such gains have been short lived, and that neither has come close to breaking the prevailing downtrend.

Gold is Inflation-Sensitive, But Interest Rates Dominate

In truth gold is responsive to inflation, but really via the transmission channel of interest rate expectations.

The metal famously offers nothing beyond the prospect of price rises or, perhaps, capital preservation. There’s no yield on offer to the gold holder, no dividend. No perks of any kind, really. So, the years of historically low interest rates seen across the world and especially in the US since 2009 have flattered the asset. When yields are generally low, or even negative, the opportunity cost of holding onto a non-yielding asset shrinks too.

Now matters have gone into reverse. With interest rates rising sharply around the world, the appeal of non-yielding gold is fading.

In truth, the most powerful influence on the price of gold is the expected path of interest rates, especially in real terms. The lower the expected real rate goes, the greater is the appeal of an asset that yields nothing. Once they start to rise, gold looks short of good points.

There is possibly a caveat or two to add here. Gold’s fortunes may yet revive if the considerable firepower currently deployed by central banks in the inflation fight starts to look ineffective. The US Federal Reserve seems to be having some success in bringing prices to heel, but it’s certainly far too early for much optimism. Other monetary authorities are yet to ramp up their efforts, and it’s far from clear how successful they will be. Don’t forget that we’ve not seen inflation targeting tested in quite this manner before. In the recent past interest rate rises have been modest and quite pain-free for central banks. They’re not anymore. Increases in borrowing costs will mean real pain for businesses and consumers.

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Gold Likely to Remain a Diversification Play

Moreover, in the increasingly uncertain economic and political environment we’re all getting used to, it’s hard to see precious metals being entirely evicted from portfolio recommendations. In hard times diversification is usually the watchword. The global environment might well become more supportive too. India may not have the world’s largest official holdings, but it has long been the country with the most gold within its national territory. In short, 1.4 billion people who have a long tradition of holding physical gold are getting richer. That may not see gold prices surge, but it’s bound to add some long-term support. Indeed, physical gold ownership is offered by retail banks across Asia in a way that would seem quite unfamiliar for most in the West.

But to participate in the gold market, it’s important to distinguish between investing in the metal and trading its shorter-term price moves.

If gold is viewed as some sort of defense against what we might call ultimate macro shocks, threats to the entire monetary system and fiat currency itself, then it seems illogical to hold it in any sense other than the physical. Gold products, exchange-traded funds and so on, make very little sense on this score, offering returns in the very fiat currencies which would supposedly be on the ropes should those macro shocks appear.

Trading price moves can of course be done via any method, but those keen to participate would be well-served to remember that what will matter over time are those interest-rate expectations even if the ‘haven’ or ‘inflation hedge’ impulses will clearly be seen to move the market from time to time.

As we’ve seen this year on a few occasions, those impulses fade before the interest-rate fundamentals, which seem to always reassert themselves.

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