So much has been written about gold. Over the last decade it has been a frustrating asset to own. My own view on gold is that it is currently an unfashionable and misunderstood commodity. I also find that a lot of what is written about gold to be cliched and the truth is more nuanced.
Many say that gold is a hedge against inflation, but this is far too simplistic. It is also not enough to say that gold is a hedge against the US dollar. Although, generally speaking I find the latter point to have more truth in it than the former.
I also find it interesting when people compare gold with prominent cryptocurrencies like Bitcoin; the main argument being that Bitcoin has the same scarcity properties as gold. In the case of Bitcoin, it has a supply cap of 21 million coins – thus it can act as a store of value; a kind of ‘digital gold’.
I think this digital gold comparison is flawed. Although gold can be volatile, it has nowhere near the same levels of volatility as Bitcoin. During the last decade Bitcoin as an asset has performed extremely well. If you had purchased some Bitcoin in 2012, today you would still be sitting on an eye watering return. The period from around 2009 to 2021 has seen assets, notably many technology and growth stocks, increase exponentially in value. It is also no coincidence that during this same period interest rates have been at mostly rock bottom levels. This period of loose monetary policy and cheap and easy money has resulted in a dazzling stock market boom in the USA. If you look at the chart of the NASDAQ index, which is full of tech and growth stocks, you will see that in 2009 it was trading at less than 1500 points. Towards the end of 2021 it had reached an all time high in excess of 16000 points. That is some unbelievable asset inflation in a period of just over a decade.
Although many staunch Bitcoin supporters will deny this, it also seems to do very well when interest rates are low and money is cheap and abundant. Rather than being a safe haven against financial meltdowns, it behaves like a speculative technology stock that goes to the moon with interest rates at 0%. A vast proportion of Bitcoin supporters are young people whose only real experience of the financial markets is the landscape over the last 12-13 years since the Financial Crisis. They have never experienced high interest rates or any long lasting bear market. I think this point is very significant; many Bitcoin holders have never experienced a prolonged bear market and high interest rates. They have never been in the eye of a catastrophic financial meltdown.
Although the returns of gold and other precious metals like silver have been poor compared to Bitcoin and many high profile growth stocks over the last decade, it should also come as no surprise. When markets are performing well and there is abundant liquidity in the financial system, gold is not one of the primary assets that tops investors lists of assets to invest in. It is more enticing to invest in speculative high risk assets that are going gangbusters. When Bitcoin and some flavour of the month tech stocks are on a tear in this loose financial environment, positive feedback loops are created as more and more investors pile in. Investors see the returns being made on these assets or they see some of their friends making a fortune and they want in too – thus the FOMO (Fear Of Missing Out) bug enfolds them.
So when does gold shine? Gold will begin to shine when feelings of total despair and hopelessness are at it’s zenith. Since the beginning of this year, the more speculative areas of the market that have been performing very well for many years until 2021 have now been experiencing dramatic falls in their market values. Inflation has roared towards double digits in the US, the UK and the Eurozone and central banks have had to increase interest rates. Yet, interest rates are still nowhere near current inflation rates. If central banks were to dramatically hike interest rates to match inflation rates I believe this would cause a financial meltdown like no other – it would far eclipse the carnage of the Great Financial Crisis of 2008-9. Although markets have fallen, they are far from this stage. There is still lots of speculation going on and inexperienced investors still playing foolish games. Inflation may have reached 40 year highs, but because interest rates are still low lots of speculation continues. The price of gold has actually been drifting downwards over the last few months and this has resulted in some commentators stating that it is a poor hedge against inflation. Yet, these commentators are missing the point. Although inflation is at high levels, there is still a lot of liquidity in the markets. There is no real urgent reason to hold gold. However, there may just come a time when interest rates increase to unforeseen levels and liquidity begins to totally dry up as money becomes more expensive. Investors panic and thus begins an amplification of negative feedback loops and FUD (Fear, Uncertainty and Doubt) kicks in. It is the moment when investors swear that they will never invest in the stock market again and that they will never ever again touch cryptocurrencies that I believe gold and by extension other precious metals like silver and platinum etc will begin to perform very well.
By Nicholas Peart
24th September 2022
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