Bullion is best known as a time-honored haven from inflation, but there’s more to its appeal, and plenty of conflicting forces at work that can excite commentators and investors.
Gold rallied to a record high and gold futures touched $2,000 an ounce as financial markets digested the havoc caused by the coronavirus pandemic. And that breathed new life into the old question of why investors still bother with what’s likely the most primitive form of money in their portfolios.
Is gold an inflation hedge?
The short answer is yes, and no. Research suggests gold’s purchasing power remains relatively stable over very, very long periods. The amount of bread purchased by an ounce of gold has remained relatively stable since the age of Babylon. But on a less-cosmic time frame, the answer isn’t as certain. Since late 2018, the metal rallied 70%, yet inflation has remained subdued, and is below the level targeted by most of the world’s big central banks. So there’s clearly more that just inflation fears at work.
So inflation doesn’t matter near term?
It does, but primarily as a component of expected real rates, the closely watched measure of interest rates adjusted for inflation. When interest rates fall, gold becomes more attractive because the opportunity cost of leaving money in the metal — which yields no inherent investment return — decreases. At the same time, as inflation rises, the reason for owning bullion in the first place strengthens.
The market’s favored gauge of real rates are yields on the U.S. Treasury Inflation-Protected Securities, which provide investors built-in compensation for the effects of rising price levels. And breakeven inflation rates — measured by the gap between nominal yields on Treasuries and TIPS yields — are a proxy for future inflation. As the U.S. Federal Reserve set a path to keep monetary policy uber-easy to fight the effects of the pandemic, breakeven rates rose, helping to drive real rates near historic lows.
Real yields and gold tend to move in tandem
So all we need to forecast gold is real yields?
Not so fast. The reason U.S. real rates matter for gold, is that they influence the strength of the dollar — the single biggest contributing factor in gold’s tick-by-tick price moves, based on an analysis of historic price correlation. And for the dollar, it’s not the absolute level of real rates that matters, but rather how they compare with those of other currency peers. And other things influence the dollar too, like geopolitical risk, elections and the outlook for economic growth.
Some traders say the dollar has been losing ground to gold this year in part because the Fed has been purchasing so much of the U.S. government’s record debt sales — potentially debasing the greenback and dimming its allure as a haven.
So gold is the anti-dollar?
Most of the time yes. Except when it’s not. In times of acute stress, both gold and the dollar tend to act as havens — and they become positively correlated. In fact, during every U.S. recession since the 1980s, the normally stable link between the metal and the currency inverted. And that’s exacerbated when the epicenter of the crisis is in other parts of the world, like during the early phases of the coronavirus crisis, or the euro zone sovereign debt crisis.
Gold’s correlation with the dollar flips during recessions
So essentially, gold isn’t correlated to anything?
That’s often seen as one of its strengths, as it lowers the volatility in a multi-asset portfolio. But again, it’s only part of the story. In normal times, gold’s moves are inversely linked to the dollar. In times of stress, though, it can take the opposite side of whatever the biggest fear in financial markets is.
Analysis by Bloomberg showed the metal’s relationship with a range of assets becomes more inverse as volatility in the counter asset increases. That’s what makes gold a haven, that it protects against generalized uncertainty, rather than any specific market risk.
Gold trades in opposition to other assets as they become more volatile
Source: Bloomberg
