Current times are tricky, and the vicissitudes of markets and global economic, geopolitical events have been mind-boggling. We are facing economic policies driven inflation, war situations, countries going bankrupt, high debt situations, and these scenarios are affecting our day to day lives. The consumer spending has got suppressed. Interest rates are on a rise, increasing the cost of borrowing. A lot of QE money that got poured into speculative asset classes like crypto currencies creating a bubble, which has busted now. A lot of emphasis was placed on how crypto currencies will be the future of currency system and will replace the investment credibility of safe-haven commodities. While I do not deny the fact that CBDC (central bank digital currency) will be a paradigm shift in future, again changing the foundation on how money will be stored and exchanged, private crypto currencies have a long way to go. For now, they are nothing but unregulated risky instruments to run one’s speculative bets on, for which there is no guarantee that money will be safe. Its accelerated ride overshadowed that of gold’s. It is interesting to note that, during the Great Financial Crisis, Gold rallied from 688 in February 2008 to 1222 in Nov 2009, delivering 78% of returns in one year. Further, rallying to 1900 in Sept 2011, thus delivering 178% since Feb 2008. Post that Gold fell came down. In my previous article, we talked about the previous inflationary situations over the century.In this note, I am covering how Gold as an investment class has performed in past and is expected in future.
Study of Gold’s price movement from 1920s onward indicate that gold prices have rallied as and when central banks printed money. Post 1929 crash in markets and the Great Depression that followed, US in 1933, announced quantitative easing measures to boost the economy. Gold rallied during from 17$ / oz in 1931 to 26.3$ in 1933 and 34$/oz in 1934. Thereafter, despite rising Inflation during the World War II period, Gold stayed muted exceptionally.
In 1971, US officially gave up the gold standard, turning US Dollar to fiat currency. This led to devaluation of dollar and loss of value of Dollar assets. Gold rallied from 37$/ oz in 1970 to 43$ in 1971, 64$ in 1972. As Inflation started to rise in 1973 due to oil shock, gold rose to 112$. These 2-3fold returns of Gold in short span could be observed as dollar lost its value due to devaluation and to some extent inflation.
Generally, dollar and gold move in different directions as they are considered as alternative safe-haven assets. As dollar loses its value, gold gains and vice versa. This inverse relationship remains even today. Correlation of Dollar Index and Gold (for period 1972 – date) is minus 0.40.
By 1979, Gold touched 582 $, fueled by further hyper-inflationary pressure. Over the next few decades, Gold’s performance remained subdued and fell to 276$ in 2000. Inflation during that time remained in range of 1-4%, and post dot-com bubble, Gold rallied again to 630$ in 2006. The Great Financial Crisis pushed gold to record levels highs of 860$ in 2008, 1087$ in 2009, 1405$ in 2010, 1531$ in 2011, 1657$ in 2012. This rally could be again attributed to QE rolled out by Fed in phases between 2008 - 2012.
Central banks responded to covid induced slowdown by record high stimulus of 6 trillion $, ballooning their balance sheets. Gold rallied from 1514$ in 2019-end to close year 2020 at 1880 after touching peak of 2000$ during the year, a gain of 25%. However, during 2021 performance of gold fell to lows of 1700$, as economies started recovering, dollar rose with higher interest rate expectations.
These events indicate that Gold’s movements has been function of hyper inflationary periods, loss of Dollar value on account of moving to fiat currency system or printing of money. As the central banks decide to raise the interest rates, and jitters of QT (Quantitative Tightening) begin, dollar gains value and gold’s performance recede. Besides, correlation of Inflation (India-annual) with Gold for period 1970 – date is 0.16.
Gold has always been believed as an inflation hedge and investor’s most preferred choice of investments during times of crisis, owing to its lower correlation with other asset classes. Gold’s utility and its value has remained universal and timeless as time and again over centuries, monetary system has pegged back to the precious metals after series of fiat currency devaluations. We cannot ignore how the actions of central banks are having a strong influence on the Gold prices. Correlation of Inflation (US-annual) with Gold Returns for period of 1955 – till date is 0.45. For period 1929 – date is 0.28. Another interesting observation is as we move behind and exclude post subprime / dot com periods, the correlation between Gold and Inflation increases. As can be seen from recent tides, gold rallied due to QE in 2020, when inflation was muted.
Gold’s price movement since 1930 also exhibits that it has glittered during majority of recessionary periods. It delivered multiple series of double digit returns during the recessionary periods over the century.
All the above observations states that Gold is strongly related to central bank policies, movement of dollar and hyper-inflationary period and recessions. Currently, interest rate hikes and strong dollar are holding down gold prices. If interest rate hikes continue, then gold performance may remain subdued. Central banks are taking an aggressive and tough stand over the interest rates, and this shall drive the gold prices in near term.
On the other side, the current situation is not plain vanilla where the only looming concern is that of Inflation. We are at the edge of recession, driven by inflation and wars and geo-political turmoil. Pandemic also has gripped large producing and consuming nations like China. While the geo-political scenario, which I do not think will settle soon, the supply side driven inflation is here to stay, coupled with shortage of necessities and resulting food crisis.
As increased interest rates poses threat to the high debt laden economies, there looks to be a limited upside potential to the interest rates. This shall drive dollar's movement in future. To avoid high debt service cost burden and to shield the economy from inflation and interest rate shock, monetary policies may change its course. The policies adopted will be guiding dollar's and gold's rally. Markets have discounted the crypto currencies with increasing risk in these asset classes, followed by crashing bond markets and equity markets. Most recently, we find global leaders and central banks doing the 'talk' while that will have temporary upswing on the markets. What we need to keep our eyes on is the 'act' for combating the downturn, for the measures will guide future of gold prices.
- Ushma Zunzavadiya
Note: Kindly note that this is not an investment recommendation for any purposes.
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