Gold prices have been on a tear lately, reaching record highs. There are a couple of reasons for this. The most common ones are the demand for gold as a safe haven asset, uncertainty around inflation and persistently high interest rates.
Let’s discuss all these reasons one by one.
Safe-Haven Demand
Physical gold as well as ETFs around the world saw a huge spike in prices in the beginning of the Coronavirus pandemic. What’s amazing is that the price never tanked even after normalcy returned. The reason for this sustained rise becomes clearer when we consider how geopolitical tension arose shortly after the pandemic.
Russia attacked Ukraine; the two countries are still at war, even though the intensity has lessened. Then, in October 2023, the Israel-Palestine conflict erupted, further unsettling global markets already on the edge from the ongoing war in Ukraine. The relationship between the US and China soared after the US president Joe Biden said in the event of China’s invasion of Taiwan, the US will help Taiwan militarily. In January of this year, The US launched missile strikes on Yemen, which exacerbated the already tense situation in the Middle-East. The recent Iran-Israel conflict and how it unfolds is under every investors’ radar. Many global indexes are already down.
All these events have made investors jittery. As a result, they have been stockpiling gold lest sudden losses caused by markets responding negatively to unforeseen global risks.
Obscurity Around Inflation
Inflation is not just a phenomenon in the US. Almost all first world countries are reeling from steady inflation that experts mistakenly believed was going to be “transitory.” We are in the second quarter of 2024 and inflation is not going down. It is safe to say that it’s anything but transitory. What’s worse than high inflation is the lack of clarity around it.
When is inflation going to subside?
Nobody has the answer. Even the fed chairman doesn’t have the answer.
February’s CPI data showed US inflation is 3.2%, slightly higher than what analysts predicted, and much higher compared to FOMC’s annual target of 2%. March’s was 3.5%, a whopping increase. These higher-than-anticipated CPI data have thrown a wrench into investors’ expectation of a June rate cut. Such obscurity around inflation has forced investors to look away from equity and other risky segments. Naturally, a fraction of them moved to yellow metal.
But even if the confusion gets cleared, Gold prices might still continue to increase as one or more rate cuts will cause the US dollar to slide against a basket of currencies. While this would be good news for emerging economies, China’s exports might suffer heavily, and that in turn could cause more financial uncertainties across global markets. Suffice to say, investors who have the foresight to see what’s ahead, have started to buy gold.
Historically High Interest Rates
Now this might sound puzzling, but gold prices moving upwards despite the federal funds rate being historically high is not strange at all.
Let me explain why.
High interest rates and gold prices are believed to be inversely proportional, as rising rates make longer dated treasuries attractive to investors, who’d have preferred the yellow metal in a low-rate environment. However, when rates remain high for an extended period of time, the economy heads towards a credit crunch. Even the anticipation of it could cause major upheavals in equity markets.
I think that’s one of the reasons why the Fed sounds so reassuring whenever they raise rates. However, action speaks louder than words, and Fed’s actions have so far been disappointing. The rate hike cycle began in the first quarter of 2022. While it has stopped already, rates are yet to be reduced.
The expectation of rate cuts is no longer enough. Investors are starting to realize that. As a matter of fact, this expectation has been doing more harm than good. It is negatively impacting two completely opposing groups of investors. The longer-dated treasury investors are afraid that in the event of a rate cut, the number of buyers would drastically reduce. Equity investors, on the other hand, cannot wait for the rate cut talk to become reality, but have zero clue how long they’d have to wait.
Investing in gold is a safe option for both groups of investors.
Insights for Gold Investors
At the time of writing this article, all major US indexes are down. They were up just a week ago. Dow Jones, NASDAQ and S&P 500 all surged on the back of strong US job data. Nikkei 225 was up as the Bank of Japan’s marginal increase of short-term rates had been met with relative calm in the Asian markets. But now, all these indexes are down due to March’s disappointing CPI data and news of Iran launching missiles on Israel. FTSE 100 and Shanghai Composite have been down for two consecutive sessions.
The sentiment among gold investors is quite positive. The only complaint I have been hearing from them is that they should have entered earlier and purchased in larger quantities. I think this sentiment is going to stay, and so if you already have gold indexes in your portfolio, don’t even think of selling. Hold on to them until markets give you further clues about the current upbeat sentiment weakening.