Gold’s Rise Is a Sign of Uncertain Times
Reprinted from the FT – 29/07/2020
By normal standards, the yellow metal is not an attractive investment. The current rise in gold is an indication of fear: what it primarily offers investors is an alternative to the dollar. Gold is not a particularly good investment. It yields no interest and pays no dividend: the only way its owners can earn a return is if other investors value the shiny metal more tomorrow than they did today.
For a “haven” asset, which investors can use to preserve capital in times of crisis, it is remarkably speculative: aside from some niche industrial uses, most of the permanent demand comes from jewelry. Its rise in value this week to a near-record high of $2,000 per troy ounce reflects the fact that many other options are even less attractive, rather than any intrinsic merits.
Many traditional “safe assets” such as government bonds similarly either yield nothing or will gradually lose their value thanks to inflation and negative interest rates.
As with gold, earning a return on US Treasuries relies on speculating that prices of the bonds can continue to increase. With interest rates already at virtually zero in the US and little indication that the Fed intends to drop them into negative territory, that does not strike many as a good bet. In that situation, some investors see gold, which is less vulnerable to inflation, as more attractive. The current rise in gold is also an indication of fear: what gold primarily offers investors is an alternative to the dollar.
Adjusting for changes in overall prices, the metal has been more expensive only twice before: during 2011, when a congressional standoff over the US debt ceiling and the potential for the eurozone to break up drove demand; and in the early 1980s, when a new Islamic revolutionary regime in Iran contributed to concerns that the, partly oil-driven, inflation of the 1970s would erode the value of the greenback. Its rise today once again reflects worries over the safety of investing in the world’s largest economy.
The dollar has likewise lost value this week against the euro, the British pound, and the Japanese yen.
Not only are geopolitical tensions with China rising — gold’s value also rose this year during a stand-off between the US and Iran — but the US government continues to mishandle the pandemic. A congressional stalemate over a second stimulus package has also prompted investors to look for alternatives to the international reserve currency. The dollar’s premier status owes as much to the fact there are few good alternatives to the currency as to the greenback’s own advantages. The euro, the only currency with similar standing, lacks the liquidity and depth of the greenback — though the launch of mutual bonds to pay for the bloc’s post-coronavirus recovery fund may help to change that. For some, gold is also a means to bet against fiat currencies and unrestrained money printing in general.
This is the backdrop against which the Federal Reserve, currently in an interest rate meeting that will end on Wednesday, will announce its latest decision. The members of its rate-setting committee should ignore the decline in the dollar which, if anything, provides relief to US exporters and a bit of extra monetary stimulus. There is little, however, they can do to help the American economy at the moment: market trading is orderly and, until the virus is contained, even cheaper money — whether through negative interest rates or yield curve control — will do little to boost growth.
Gold’s rise may be overdone.
History suggests that it rarely maintains these sorts of levels and the wave of fear over the future of the US and the world economy that propels it eventually breaks. For the moment, those fears are grounded, but gold’s disadvantages may soon become clear again.