News Column

Gold is no longer seen as an effective inflation hedge

August 23, 2014

But monetary policy and inflation expectations have an impact on the price direction

How's this for poor taste? "Gold prices have risen following news of the potential shooting down of a Malaysia Airlines plane in the [sic] Ukraine."

That line is from a press release issued in mid-July. It went on: "The ramifications from today's news are likely to trigger renewed interest in gold buying as worried investors seek out the safe haven metal." Gold was around $1,300 an ounce then. A month later, with tension still high in Ukraine, almost 2,000 dead in Gaza and militant Islamists rampaging across Iraq, the gold price stands at $1,315 an ounce.

Since the start of a year characterised by unexpected geopolitical events, the gold price is up 7.3 per cent in dollar terms. Thanks to the appreciating pound, the return in sterling has been lower, at 4.9 per cent. Shares, as measured by the All share index, are down about 1.8 per cent while Bloomberg'sUK sovereign bond index is up 5.7 per cent.

You know the gold bugs are getting desperate when they invoke the "safe haven" argument. It all goes back to 1980, when the Soviets invaded Afghanistan just as the Iranians barricaded several hundred Americans inside the US embassy in Tehran. Gold reached $850 an ounce back then, or more than $2,000 in today's money.

But the world was a very different place in 1980, both in terms of geopolitics and finance.

As Adrian Ash at BullionVault points out, geopolitical crises these days trigger only the most transitory buying of the yellow metal. "Speculators trading gold futures and options do move the price by raising their betting on breaking news, but such moves tend to be brief." Mr Ash says the two Gulf wars, 9/11, Syria, Ukraine and now Gaza had little lasting effect on gold prices.

So what does move the price? According to BullionVault customers, monetary policy does. A third of them believed so, compared to less than a fifth who believe geopolitical factors did, and only 14 per cent who thought inflation was the driving force behind prices.

They're right about inflation. As London Business School academics noted two years ago, gold is the only asset that does not have its real value reduced by inflation, but its long-term returns are too poor for it to be considered true protection against inflation. "Gold can fail to provide a positive real return over extended periods," they said. Its average return in real terms has been just over 1 per cent a year.

It doesn't offer much protection from falling stock markets either (14 per cent of those surveyed believed equity markets drove gold prices). According to Mr Ash's research, the gold price (in sterling terms) was inversely correlated with the UK stock market for only about half of the past 40 years.

Are they right about interest rates? I can't see any obvious reason why gold - an asset that generates no income and has few productive uses - should be correlated with interest rate movements. But I can see why it would be connected to the end of ultra-accommodative monetary policy; after all, everything is. The mechanism is not financial, but psychological. Uncertainty drives the buying. Gold is viewed as insurance against things that are difficult to predict and unlikely to occur, but which would be very expensive if they did.

Like, for instance, the complete implosion of the financial system in an inflationary firestorm following decades of irresponsible money creation.

Many clever and rational people believe this is a distinct possibility, even as economies around the world recover. They may be right; sovereign and individual indebtedness is still far too high in many countries, including the UK.

Does that mean I'll put some physical gold trackers in my Isa, when I finally get around to rebalancing it? I remain to be convinced. A 5 or 10 per cent allocation to gold - the amount most advisers seem to think is reasonable - isn't going to save my bacon if the unthinkable does happen and everything else tanks. In the meantime it's dead, yieldless money.

Besides, I figure that if western civilisation does collapse, I'll have more pressing things to worry about than the state of my investment portfolio. As David Stockman (a former adviser to President Reagan) once memorably said, bottled water, canned beans and flashlight batteries will be the places to be invested.

For more stories on investments and markets, please see HispanicBusiness' Finance Channel

Source: Daily Messenger (Pakistan)

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