Financial markets in 2022 have been turbulent. The causes behind this have been well documented, including record levels of inflation being met by tightening central bank policy, uncertainty regarding global growth and ever-increasing geopolitical risk.
During such uncertain times and especially during periods of high inflation, gold is considered by some as a safe haven from volatile markets and reliable protection against rising inflation. Gold’s performance has been puzzling in the last 5 years, performing well between 2018 and 2020 as the US experienced benign inflation, and has remained flat most recently despite record levels of inflation.
Although gold does have a relationship with inflation, what is more important for the metal is its relationship with inflation as a component of real rates. Real interest rates are the difference between nominal yields and inflation, generally measured by the yield on US inflation linked bonds. Another way to think about this is it’s the return you get after taking inflation into account.
The relationship between gold and real rates has held over this period as we would expect – as rates decrease, the opportunity cost of holding gold (a non-yielding asset) is less and therefore makes gold more attractive. In other words, if the ‘cost’ of holding gold is the real interest rate you forego by holding gold, then if this rate is lower the cost is less. The decline in real rates in 2022 partly explains gold’s performance.
However, real rates are only important for gold as far as they influence the strength of the dollar. The US dollar is, in fact, the biggest contributing factor to gold’s more short-term price moves.
Gold and the US dollar generally have an inverse relationship, meaning they move in opposite directions of each other. The dollar is influenced by many external factors such as geopolitical risk and the outlook for macroeconomic growth. This relationship holds except in times of stress, where gold and the dollar become positively correlated (meaning they move together) as safe havens. The below graph shows the highest positive correlations have occurred during US recessions. The positive correlation is also amplified when the cause of stress or uncertainty is outside the US, such as during the Euro-area debt crisis. In 2022, the relationship was positively correlated following Russia’s invasion of Ukraine and has returned to normal as the US Federal Reserve has become increasingly hawkish, raising rates and driving real rates higher.
Does the above mean that gold is no longer an appropriate inflation hedge? Well, gold’s benefit may be that it lowers volatility in a multi-asset portfolio and trades in opposition of other financial assets in times of stress. The metal could, therefore, be seen as a component of a balanced portfolio. Like all financial assets, gold’s performance can be affected by short-term market fluctuations and speculators.
Source: Bloomberg data as at 3 September 2022