Gold is always fun to analyse.
But right now, it is particularly intriguing, what with all the chaos in the world economy and a spiralling cost-of-living crisis.
This is because gold has traditionally been viewed as a hedge which performs well in both times of uncertainty (recession) and high inflation. And if 2022 gave us anything, it was uncertainty and inflation.
Gold performs well during recessions
I wrote a deep dive on the metal last year, concluding that gold tended to strengthen in times of recession.
The pattern is shown in the above chart. And yet, detractors will point out, why did gold not surge during the previous year, when recession fears were cranked up to maximum volume, as war broke out in Europe, energy prices spiked, and interest rates were hiked to oblivion in order to curtail an inflation crisis?
Well, a couple of things. Firstly, inflation and gold don’t have as symbiotic a relationship as many believe. Sure, it has tracked inflation reasonably well – certainly better than a lot of assets – but it is hardly a hand-in-hand relationship. The below chart shows this.
Nonetheless, the chart clearly shows a notable divergence as inflation mooned last year, while gold did…nothing. The shiny metal opened the year trading at $1,830 per ounce. One year later, following a turbulent year (to put it mildly), it closed the year trading at $1,820 per ounce.
But before we bury the metal for refusing to surge in what was, ostensibly at least, a perfect set-up for it in 2022, let us look at another chart from the past year.
That is dollar strength. I discussed the dynamics of the dollar’s relationship with gold in a podcast on the thesis behind investing in gold last week with Adrian Ash, Director of Research at BullionVault.
“The way it tends to work in my experience with the dollar is that a rising gold price in dollars tends to be good for non-dollar investors as well; a flat gold price in dollars typically also tends to be good for investors in other currencies”, Adrian Ash.
In fact, this is what we have seen. While gold’s price in dollar terms will always take the headlines, and hence it is tempting to conclude that the asset hasn’t done much over the past year, the situation is very different when looked at it from a foreign angle.
Denominated in GBP, gold returned 14%. In Euro, investors enjoyed a 10% boon.
Another way of putting this, of course, is that both the euro and pound sterling got crushed last year (which I discovered to my own chagrin when I travelled to USD-denominated Ecuador last summer).
Gold can be used to compare currencies
It’s actually just another way to assess the strength of currencies. Just for fun and games, I plotted gold against both the euro and the dollar going back to 2003:
It definitely provides an extra bit of context. As Ash said, a flat gold price in dollars has traditionally been a good thing for investors of foreign nations. That is what comes with the dollar claiming the status of the world’s reserve currency.
So while it is tempting to declare 2022 a disappointment for gold, think of us Europeans out there. Not to mention the fact that even in dollars, the price is sitting quite pretty, trading at $1925 currently, not far from its all-time high of $2,058 in 2020 – albeit, that return still pales in comparison to risk assets, even after 2022’s pullback.
What next for gold?
The last month has been kind for gold. Which is interesting, as it has been kind for risk assets too, which traditionally are uncorrelated from the metal.
This parallel relationship currently sums up the unique spot markets are in, with all eyes on central banks and interest rate policy. Equities and risk assets have jumped off the back of softer inflation rate, as the market now anticipates a pivot off high interest rate policy will come sooner than previously expected.
This pivot to more accommodative monetary policy also means that inflation could pick up again down the line, and hence gold’s hedge narrative has strengthened, with the metal climbing.
In Euro, it is trading at €1,772, right at all-time high levels. In pound sterling, it is trading at £1,558, also around all-time highs. This strength, more than anything, sums up the torrid demise of the European currencies in recent years.
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