Tthe raders have a phrase to describe how unpredictable financial markets can be: “better off, stupid”. Stocks or other financial markets can sometimes behave unpredictably. Analysts predicted that US stock prices would collapse if Donald Trump won the election in 2016 – they soared. Companies that post better-than-expected earnings sometimes see their stock prices decline. Having a glimpse of the future should give a trader an edge, and it would most of the time. But not always.
Let’s say you knew at the start of 2021 that inflation was going to soar, the result of widespread money printing by central banks and extravagant fiscal stimulus. Furthermore, you may also have known that inflation would then be fueled by trench warfare in Europe. With such knowledge, there is perhaps one asset among all others in which you would have invested all your savings: the precious metal that adorns the necks and wrists of the rich in countries where inflation is a permanent problem.
Better to be stupid, then. The price of gold has barely changed for two years. As of January 1, 2021, an ounce cost just under $1,900. Today it costs $1,960. You would have made a princely gain of 3%.
What is going on? Determining the right price of gold is a difficult task. Gold bugs point to the metal’s historical role as a silver-backing asset, its use in fine jewelry, its limited supply, and its physical durability as reasons for why it holds value. After all, at first glance the phenomenon is strange: unlike stocks and bonds, gold generates neither cash flow nor dividends.
But this lack of revenue also gives a clue to the metal’s lackluster returns in recent years. Because gold generates no cash flows, its price tends to be inversely correlated with real interest rates: when real, safe yields, such as those generated by Treasury bonds, are high, assets that do not generate no cash flow become less attractive. For all the furor over rising inflation, the rise in interest rates has been even more remarkable. As a result, even as inflation soared, long-term expectations remained surprisingly well anchored. The ten-year Treasury yield, minus a measure of inflation expectations, has fallen from around -0.25% at the start of 2021 to 1.4% today.
In 2021, researchers at the Federal Reserve Bank of Chicago analyzed the main factors driving gold prices since 1971, when America abandoned the gold standard, a system under which dollars could be converted into gold at a fixed price. They identified three categories: gold as a hedge against inflation, gold as a hedge against economic disasters, and gold as a reflection of interest rates. They then tested the price of gold against changes in inflation expectations, attitudes toward economic growth, and real interest rates using annual, quarterly, and daily data.
Their results indicate that all these factors do indeed affect gold prices. The metal appears to protect against inflation and rising prices when economic conditions are gloomy. But the strongest evidence concerns the effect of rising real interest rates. The negative effect was apparent regardless of the frequency of the data. Inflation may have been the most obvious driver of gold prices in the 1970s, 1980s and 1990s, but, the researchers noted, starting in 2001, long-term real interest rates and views on economic growth dominated. The way gold prices have moved since 2021 seems to support their conclusion: inflation is important, but real interest rates matter most.
All of this means that gold could serve as a hedge against inflation, but inflation is not the only important variable. The price of the metal will rise during times of inflation if central banks are asleep at the wheel and real rates fall, or if investors lose confidence in policymakers’ ability to bring it back under control. So far, neither has happened during this inflationary cycle.
A little knowledge about the future can be dangerous. “The Gap in the Curtain,” a science fiction novel by John Buchan published in 1932, tells the story of five people chosen by a scientist to participate in an experiment that will allow them to gain a glimpse of a year into the world. future. Two end up seeing their own obituary. It is “the best investment book ever written”, according to Hugh Hendry, a Scottish hedge fund investor, because it encourages readers to look to the future while thinking deeply about the exact causes of certain events. As gold’s recent seemingly confusing moves suggest, unanchored forward-looking is a dangerous habit.■
Read more from Buttonwood, our financial markets columnist:
Can anything burst the bubble? (4th July)
Americans love American stocks. They should look abroad (June 26)
Why investors can’t agree on the financial outlook (June 22)
Also: How the Buttonwood column to his name