Gold bugs – investors perpetually bullish on gold – have long been seen as a paranoid fringe of the financial world, holding the shiny asset as a hedge against a disaster they always think is near. But lately they appear to be on to something. This year gold is the best performing traditional asset in the world. Its price just topped $2,000 an ounce for the first time.
From serious investors to newly minted day traders, everyone is talking up its virtues. A recent survey of 1,000 people found that one in six Americans bought gold or other precious metals in the last three months, and about one in four were seriously thinking about it. On Robinhood, the popular online trading platform, the number of users holding two of its largest gold funds has tripled since January.
It seems we’re all gold bugs now.
It’s tempting to attribute the vogue for gold simply to a desire for a safe haven during the pandemic – a kind of financial panic reflex that will release as the crisis abates. But the gold mania is also driven by a hunch that the easy money pouring out of central banks and government stimulus programmes could trigger inflation, which makes it a more worrisome economic omen.
Serious investors have in the past dismissed gold as an asset that for the most part just sits there yielding nothing. In many ways gold is much like oil or iron ore or any other commodity people dig out of the ground. Most commodity prices rise and fall in cycles, gaining nothing in value over time.
Owing to its image as a stable store of value when others are shaky, gold has held up better than other commodities, but it still hasn’t been a dynamic investment. Over the past century, the price of gold, adjusted for inflation, has risen by an average of just 1.1% a year, compared to 6.5% for US stocks. Even the 10 year US Treasury bond, considered the most risk free asset in the world, has produced higher annual returns. That is why gold bugs have looked like losers over time.
Gold has shone mainly in hard luck moments. It surged amid the stagflation of the 1970s, rising more than sevenfold over the course of that decade to peak at $850 in early 1980. It surged again after the global financial crisis of 2008, peaking at $1,900 in 2011, but then slid backward over much of the subsequent decade.
In 2019, after the Federal Reserve signalled it was suspending plans to push interest rates higher, gold mounted another ascent. Historically, gold has done best when interest rates fall below the rate of inflation. As the inflation adjusted return on bonds turns negative, investors feel comfortable owning gold as a store of value, even if it yields nothing.
That is what has been happening over the past few months. With bond yields near zero in the US and negative in Europe and Japan, investors have driven up the price of gold more than 30% this year after a gain of nearly 20% last year. In recent weeks, that surge has been turbocharged by growing expectations that all the money governments are pumping into their economies will reignite inflation.
In addition, with valuations of stocks well above their long-term average, gold appears relatively cheap. And with central banks printing money hand over fist, some see gold as a stable alternative to the dollar and other major currencies.
By many measures, gold has room to go up. The typical investor still holds just 3% of his or her portfolio in gold, compared to the 1980 peak of 6%. And the global gold market is just 16% the size of global stock markets, compared to past peaks of 40% in 2011 and 200% in 1980.
For gold to keep rallying, expectations of inflation will have to keep rising. Anticipating higher inflation has been a losing bet for a large part of the last four decades, but the odds appear better now. Most nations are doling out record levels of stimulus at a time when forces like globalisation, which kept inflation in check, are weakening. Normally, if inflation looms, central banks can be relied on to raise interest rates, but Fed officials have signalled that they aren’t “thinking about thinking about” raising rates, and don’t expect to move before 2022.
This is not a healthy turn. When interest rates are this low, money is virtually free, encouraging speculation in assets of no value to society, beyond what the seller can get for it. Gold is the prime example now, but it is also pulling up the price of its less glamorous relative, silver, which is rising from a depressed level because people see it as a cheaper play on the same trends.
The wider risk is that this kind of purely financial speculation undermines the economy by sucking capital away from industries that will put it to more productive use. As an investment, gold has none of the virtues I admire, like innovation and dynamism, and many of the vices I despise, including the “rent seeking” mind-set typical of extractive industries. But these times aren’t normal. Unless a vaccine emerges quickly, central banks stop printing money frantically and real interest rates start rising again, it is difficult not to be a gold bug now.