“We usually say that the price of gold increases during periods of inflation. It is also said to increase when there is a lot of uncertainty. However, despite the fact that these two factors come together, the price of gold has been fairly stable for two years and has even fallen recently. Is the above statement wrong or are there other factors? »
— Jacques L.
Posted at 8:00 a.m.
Gold is considered a safe haven because the precious metal is weakly correlated with financial assets like stocks and bonds.
Since the beginning of 2022, a period of great concern and high volatility on the financial markets, the price of an ounce of gold has appreciated slightly by 3%. By comparison, the Dow Jones index lost almost 10% of its value, and the NASDAQ, an index of stocks with strong technological coloring, did much worse, slipping 22%.
So, as we can see, the price of gold does not fluctuate in the same direction or in the same proportions as the price of shares.
Second, it is often said that gold provides protection against long-term inflation, which does not prevent unexpected reactions in the shorter term.
To demonstrate gold’s long-term protection against inflation, let’s compare gold to a tangible asset like a house.
In the United States, buying a house in 1915 cost $3,200, or about 155 ounces of gold at the price at the time. At today’s price, 155 ounces of gold represents a value of US$291,710. In February 2022, the Case-Shiller index of home prices in the United States stood at…US$286,679. It’s almost magical.
If house prices were to continue to rise in the United States, it’s a safe bet that over time, the price of gold would adjust accordingly, as it has done so well in the past.
Gold also reacts to geopolitical events. The metal neared its all-time high on March 8 in the days following the invasion of Ukraine. This fear reaction is often short-lived. Gold also fell rapidly when the market realized that the outbreak of World War III would not take place immediately, thank God.
Of course, factors other than inflation and war influence the price of gold.
Interest rates are one. When the return an investor hopes to earn on a safe investment, such as 10-year US government bonds, increases, the opportunity cost of holding gold increases since bullion does not earn income. Gold thus becomes less popular, and its price reacts downward.
Currently, the tepid reaction of the price of gold to inflationary pressures reflects the market’s confidence in the ability of central banks to slay the dragon of inflation as soon as possible, by aggressively raising interest rates. If so, the price of gold will go nowhere.
Time will tell if our St. Georges of the Fed and the Bank of Canada will meet this challenge successfully, after all, they are the same two people who for months claimed that inflation was transitory.
In the meantime, real interest rates remain in negative territory in both Canada and the United States. For example, the yield on 10-year US bonds is around 3%, while the inflation rate is around 8%. One minus the other, the difference gives a negative return.
In the past, gold was able to hold its own in a context of negative real rates, the firm Incrementum AG aptly recalls. In periods of negative real rates between 1971 and 2021, the annualized rate of return on gold after inflation was 11.4%, according to figures reported in its annual report titled In Gold We Trust.
It is relevant to point out that gold sold at a record average annual price in 2021, the year when inflation finally showed the tip of its nose. It stood at US$1798.89 in 2021, higher than US$1773.73 in 2020.
Journalist André Dubuc is the co-author with François Riverin of the book Investing in Gold – The New Klondike for Everyonepublished by Guy Saint-Jean Éditeur