Gold prices over the past month have been on a tear, up 3.91% but for the year the return enjoyed by goldbugs has paled in comparison to the market. The S&P 500 is up 20.15% whereas gold has climbed by just 12.25%.
Speculation is growing that the precious metal is on the cusp of breaking out but when does gold go up usually? Is it in times of inflation as so many assume or are other factors at play?
When Does Gold Go Up?
Historically, gold goes up during periods of decline in government confidence versus inflationary periods as is widely believed.
When the Federal Reserve began it’s quantitative easing policy, gold bugs widely assumed that inflationary pressures would drive up the price of gold. In fact, over the past 5 years gold is up just 62%, falling short of the S&P 500 return of 74.5%.
Still, gold has a reputation as a safe haven during periods of economic turbulence. It’s easy, as a result, to conflate gold price hikes with inflation, particularly when looking back in history at times like the 1930s in the Weimar Republic when it shot up in price. Given that inflation soared then, it is easy to conclude that gold goes up with inflation, but in reality the precursor was a collapse in confidence among the public in the local government.
Indeed government’s role in shaping gold prices is real. A combination of central bank’s monetary policies setting interest rates or controlling money supply as well as fiscal stimulus, such as government spending and tax cuts, can create favorable conditions for higher gold prices but the correlation is not as straightforward as 1:1.
For example, correlations can be drawn between gold rising in price and inflationary debt increases but they don’t track linearly. Take 1970 when U.S. Debt was $372 billion and gold was priced at $35/oz versus a decade later it had increased to $653/oz with debt reaching $863 billion. Debt more than doubled but gold almost 20x’ed.
Fast forward to today and gold is closer to $2,000/oz while debt is at $31 trillion. So debt went up by over 30x since 1980 but gold has gone up by closer to 3x, suggesting an order of magnitude differential. It’s clear that some correlation between debt ballooning and gold rising exists but it certainly doesn’t track linearly.
Where gold prices tend to really soar is when geopolitical risks surface and government stability comes into question. For example, trade wars, military conflicts and civil unrest all tend to drive short-term demand for gold as a safe-haven asset.
Gold prices are sensitive to geopolitical risks and government stability. Events like trade wars, military conflicts, or political unrest can drive demand for gold as a safe-haven asset, affecting its price significantly.
How Financial Crisis Affects Gold
Interestingly, gold is viewed as having an inverse relationship with other assets like stocks and bonds. Notably, though, the spikes in gold tend to occur short-term during crisis periods when other markets are performing poorly.
History has shown a correlation between gold prices rising and financial crises. In 2008, gold rose from $740 per ounce to over $1,100 an ounce a year or so later, underscoring the precious metal’s resilience to financial turmoil.
So too in 2011 during the debt ceiling crisis did gold hit a record high of $1,910 per ounce, but once the crisis was resolved, a notable decline in gold prices followed. The inference was clear that demand spikes during a financial crisis and periods of high uncertainty but a mean reversion quickly follows when clarity appears.
Helping support the case for gold at these times is its liquid nature wherein investors can buy and sell easily during a period of financial turmoil. This is especially valuable during major currency devaluations. For example, when a government devalues a currency relative to the US dollar, gold prices generally go up in the local currency.
So when does gold go up? Gold typically rises during periods of economic uncertainty, inflation, currency devaluation, geopolitical tensions, low interest rates and market volatility.
Although there is a broad interpretation that gold goes up when the supply of money increases, one of the largest expansionary periods in history took place during the past decade and, over that period, gold failed to rise commensurate with the increases in dollars in circulation.
One of the primary reasons for the misinterpretation is because when hyperinflation took hold in the Weimar republic in the 1930s, gold prices soared. But what preceded the inflation spiral was a collapse in confidence in the government and that led to the public flocking towards gold as a safety net for their wealth.
No doubt there is some influence on the price of gold from factors such as QE and interest rates, as well as other mechanisms of monetary policy employed by the Federal Reserve. So too devaluations in local currencies and concerns of war and other geopolitical tensions tend to impact the price of gold.
But for the most part, the breadcrumbs to when gold will climb in price in a hurry can be traced to when the public is losing their trust in government.
The key for a gold breakout is usually when it breaks out in numerous currencies too, not just a single one due to local factors.
Right now, it appears in US dollars, gold is indeed breaking out to new highs and could be on the cusp of a new bull run. So far, year-to-date, though, investing in the S&P 500 has remained the smarter and more lucrative bet to building wealth.
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