With no gold rush, are investors really worried about inflation and a growth slowdown?

Despite warnings about rising inflation amid supply-chain disruptions and tight labour markets, the gold price has defied expectations and remained steady
As inflation pressures ease and central banks shift away from emergency policy settings, investors will look elsewhere for income and diversification

Kerry Craig

Published: 2:30pm, 5 Nov, 2021

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Gold is one of the world’s oldest financial assets and often seen as a safe harbour when capital markets get choppy. It is considered a hedge against rising inflation and a store of value in the face of economic calamity.

In 2020, gold prices soared to an all-time high as the world was turned upside down by the Covid-19 pandemic and investors sought protection from falling equity markets.

Despite the increasing voices warning about the threat of inflation from disrupted supply chains and tightening labour markets, as well as the risks that these pose to the outlook for growth, the gold price has actually been relatively stable since the middle of the year.

If there were genuine risks of another collapse in global economic activity and surging inflation, shouldn’t the gold price be much higher? Is this a signal that investors aren’t really concerned about growth and inflation?

Gold has historically exhibited a strong negative correlation to equities, particularly when inflation is high, as was evident in the 1970s. Gold has provided positive returns during shocks to the growth outlook and when inflation has soared.

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But it is at the extremes of growth and inflation when gold does best. In periods of moderate growth and moderate inflation, returns are less appealing.

Owning any asset involves a trade-off and opportunity costs, and gold is no different. The trade-off with gold is that it is an effective insurance policy against the extreme but not the mundane.

Perhaps crucially, it does not provide any income. There are a range of other assets that could diversify a portfolio, hedge against inflation and provide an income.

It is this trade-off that is keeping the gold price supported against what is still a positive economic backdrop and one in which inflation pressures are likely to moderate from today’s elevated levels. To provide ballast in portfolios against equities, investors have held government bonds.

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Bond yields have fallen for the past 25 years as inflation was tamed and central banks brought forward new policies such as quantitative easing to support economic growth. This made holding bonds much easier.

Today, holding bonds – particularly the government bonds of major developed markets like the United States – is much less appealing as yields have been rising. This means the price of those bonds is falling and investors are looking at a capital loss.

In the past, the higher coupon may have been enough to offset some, or all, of that loss. However, today’s coupons are too thin to cushion the fall.

Then there is the inflation-adjusted yield, or real yield. Inflation rates are higher than the headline yield on bonds, which means real yields are negative.

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This is where gold looks more appealing – a store of value that offers no income is better than one that offers a negative return. In August, the real yield on the US 10-year Treasury fell to its lowest level in more than a decade.

Real rates might remain negative as the rate of inflation is likely to be higher than the nominal yield on government bonds for a while.

While the current high rates of inflation around the world will probably come down as supply and demand imbalances correct themselves, it is taking longer than anticipated. This means gold will remain relatively attractive in the short term.

However, as inflation pressures ease and central banks shift away from the emergency policy settings now in place, real yields will start to rise and the trade-off of holding gold will increase. Investors are then likely to look for other assets that can fulfil the roles of diversification and income generation.

Those investors who believe inflation will remain at elevated levels might want to own gold to protect against this risk. Similarly, if you think another recession is around the corner, gold might make sense.

However, if, like me, you foresee continued global economic recovery, sticky but not excessive inflation and the normalisation of central bank policy, then gold does not shine so brightly.

Kerry Craig is a global market strategist at JP Morgan Asset Management

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