The price of gold has made headlines with the price per troy ounce exceeding $4,000 recently. This has created a buzz around gold that it has not had since the 1970s when the price of gold soared after the US abandoned the goal standard. Of course, that history also offers a cautionary tale as gold peaked at $850 per ounce in 1980, and then dropped to as little as $250 per ounce, and then stayed there for decades. From an investment performance standpoint, gold was one of the worst investments one could have made in the 1980s and 1990s as the price volatility was three times that of the US stock market while the return was closer to the rate of inflation. So, what is driving the strong returns in gold this time and will history repeat?
Some describe golds strong performance as a part of a debasement trade. Debasement is when nations make their currency less valuable by printing large amounts of money or borrowing large amounts through deficit spending. Given the current US debt and deficit, one could understand the concerns over the debasement of the US dollar. Some also reference the increase in other assets, such as Bitcoin, as a sign that the debasement trade is gaining momentum. However, one would expect to see signs of a debasement trade in the bond market in the form of high interest rates if that were really the concern. After all, why would investors accept relatively low interest rates if they believe that the value of the money they have lent will be reduced over time? Given that the bond market is one of the most competitive and liquid markets in the world it would be expected that a debasement trade would be manifested in the bond market before it would appear in other, smaller markets. Therefore, while the debasement trade may be one of the reasons that gold prices have surged recently it is unlikely to be the only reason given the lack of confirmation in other areas. Instead, there may be more to the recent increase in gold prices than just government fiscal policy.
Another explanation for the increase in gold prices could be that gold is often a good diversifier for US stock holdings. Often, when stock prices fall because of economic fear or uncertainty the price of gold increases. Therefore, some investment firms choose to hold gold rather than money markets or bonds to diversify their holdings and reduce their overall risk level. Given the strong performance of US stocks in recent years, as well as the high level of volatility during Covid and in 2022, some investors appear to be adding gold to their portfolios in order to trim risk. However, with US stocks and gold going up at the same time, the diversification benefits of the past may not hold in the future as a decline in stock prices may cause investors to sell gold to buy shares while prices are down.
Another explanation is the behavior of global central banks following the beginning of the war in Ukraine. The US government primarily responded to the war in Ukraine by implementing financial sanctions against Russia and some of its allies. This has caused many countries to look for alternative ways to settle financial transactions given the restricted access to US financial markets. Many of these countries have turned to gold as a store of value and a way to settle balance of trade payments. Central bank buying has accounted for a large portion of the increase in gold demand.
Finally, there is the mania aspect of investing. People often buy assets because they hear of others making money on the trade. These manias have impacted a variety of assets in the past few decades from US internet stocks in the late 1990s (down 85% from peak to trough), Chinese stocks in the early 2000s (down 90% from peak to trough), and US real estate from 2002 to 2006 (down 50% or more in some areas). Often when an asset class posts strong returns the price momentum takes on a life of its own, pushing prices to excessively high levels which eventually leads to an equally large correction. It is reasonable to ask the question: Will gold be next?