Gold is getting back its classic glitter as a safe inflation hedge

 Last year, there was much talk about who the “mystery buyer” in the gold market was..
Last year, there was much talk about who the “mystery buyer” in the gold market was..


It has held value for millennia while fiat money keeps losing power.

When I recently talked to some school children about the nature of money, I brought props: a cowrie shell, a piece of play paper and a small handful of shredded dollar bills. Which of these, I asked, is money? The point I wanted to make: It is all about belief. If everyone agrees something is money, it is. One child interrupted me just as I was getting going on the rai stones of Yap to ask: Can fiat currencies survive? Not what you might expect from an 11-year-old.

The answer was that it depends what one means by survive. Carry on for many more decades under names like dollars, euros, etc? Sure. Do so without losing purchasing power? Not a hope. Even inflation at 2% each year halves the value of your money in 36 years. And that target for the long-term is something of a distant dream right now. Retail inflation is down to 6.5% in the US and it will fall further, but it is very unlikely to settle at 2%, the Fed’s target.

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We live in a world of big government, one in which the answer to anything is more state spending and investments (in green energy, for instance). Deficits and debt will rise as a result. At the same time, supply chain shifts will make everything more expensive, as will rising labour costs around the world. The disinflationary effects of China entering the global workforce are over. So inflation is with us for the long haul and cash in hand is only a temporary king.

This us to discuss whether there is anything that stays money forever. Enter real gold, the only thing that has kept its purchasing power for millennia. So you might have expected gold to be all the rage last year. It was not. Instead, even as inflation hit close to 10% in the US, pretty much everywhere, the gold price (in dollars at least) did nothing. Gold mining shares, a good way to get leveraged exposure to gold, fell more than 8% and demand for gold ETFs fell for the second year in a row. Exasperating stuff.

Still, gold did pick up toward the end of 2022. Its dollar price is up some 15% since the start of last November and the miners have begun to come good too. Outflows from gold ETFs also slowed for the third month in a row in December, with the US even seeing mildly positive demand.

This year, gold’s price is up 7% in the last month in dollars. Since gold has been allowed to trade freely, there have been 10 periods in which US benchmark rates have peaked. Theoretically, a peak in rates is a positive for gold, which offers no yield so looks less attractive as an investment as interest rates rise and more attractive as they fall. But it works in real life, too. Look at the periods five months before each peak (possibly roughly where we are now given the US inflation trend) plus six months, and you see that gold averaged a gain of 18% during these times and outperformed the S&P 500 by 9.7% through the rate peaks.

There’s more. Recessions have followed the rate peaks within 18 months 60% of the time (the average being 10 months) and gold has shown a strong tendency to do well in these periods too (beating the S&P500 by 26%), particularly when recession coincides with a stock market downturn. Regardless of what regulators say about past performance telling us nothing about the future, this does give good reason to think about gold in the short-term.

It is also worth thinking about who’s buying gold at the moment. Last year, there was much talk about who the “mystery buyer" in the gold market was. It wasn’t money managers in the US, but central banks. Overall, the World Gold Council estimates that central bank buying has lifted gold reserves to their highest level since 1974, with massive purchases from Russia and China being key. The People’s Bank of China (PBoC) bought 62 tonnes of gold in November and December alone. Why? Probably to build reserve currency status, hedge against the dollar in the wake of rising sanctions risk, and also diversify—all things are possible given the geopolitical environment.

Not all are convinced by the case for gold. Chinese buying, some say, has created a $150 per ounce mispricing in the market, one that will correct if China stops buying.

But you could look at this the other way around and take Chinese buying as a clear reminder that gold is one of the few things that everyone thinks is money—from the precocious 11-year-old I met last month to the heads of every central bank in the world. As Alex Chartres of Ruffer recently said on my podcast, there aren’t many other things you can turn to as a long-term safe haven in today’s markets.

A year ago, some thought Bitcoin might be a rival—‘digital gold’ even. The market has now ‘knee-capped’ that idea. These days, if you want gold, you would need to buy, well, gold. That being the case, the question is not have you too much, but have you enough of it—the very same question the head of the PBoC is clearly asking himself right now. 

Merryn Somerset Webb is a senior columnist for Bloomberg Opinion covering personal finance and investment.

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