As the pandemic continues to ravage economies across the world, the price of gold has touched a record-new high of $2,000 an ounce. That gold prices tend to rise during economic crises – or even tensions on the international political arena – is nothing new. Gold rates reached record-breaking heights in the 1970s stagflation, and shot up again in the financial crisis of 2008. Is the ongoing economic situation comparable to the aforementioned ones, now that gold has become so expensive? This is an interesting question, but one we will unfortunately not be answering. We will, however, inspect why gold continues to behave the way it does. That stock markets around the world are doing well along with the surge in gold prices (when the pandemic is far from over) is another dimension we will try accounting for.
A Safe Haven
Gold is not a productive asset; it does not yield anything new. Investments made in gold are not profit driven as much as they are in order to minimise risks. What makes this precious metal glitter in the eyes of investors, among other reasons, is its durability and limited supply – the same reasons for which it served as the gold standard till the 1970s, and is still kept in the vaults of central banks across the world. If a currency begins to decline and people’s confidence in it begin to waver, gold starts seeing high demand owing to its virtue as a stable store of value. Stock market declines are another reason demand for gold may rise, as people scramble to make their investments hazard-free.
As stated earlier, we are currently amidst a stock market rally. However, this wasn’t the case a few months ago. In the first week of March, coinciding with the breakout of the pandemic, the US’ Dow Jones Industrial Average and the S&P 500 index saw their greatest fall since the 1987 stock market crash. Similar blows were dealt to the stock market indices of the UK, Canada, Italy, Brazil and other countries. The battle against the pandemic is far from over, and more importantly, the economies remain battered. Why, then, have the stock markets recovered most of their losses, and continue to be buoyant? As we looker deeper into this, we will also gain some insight on gold’s performance.
Bullish in Dark Times
It is intuitive to think that the stock market’s performance is positively correlated to that of the economy. More specifically, the stock market is said to be a ‘leading indicator’ of the economy – the stock market reflects what the economic situation is likely going to be in the future. The expectations for a vaccine for COVID-19 to be available by the end of the year, coupled with rounds of fiscal and financial stimuli being pushed by the government, portends well for the economy, and the stock market’s optimism is perhaps mirroring this.
In the current equation of the stock market and gold prices, the most significant role seems to be played by interest rates and bold yields. Interest rates are generally lowered to boost economic activity; in times of economic expansion, low interest rates can also spell inflation. A bond is a type of investment that earns a fixed investment; thus, in times of inflation, the adjusted-value of bond yield will be low. Inflation is also a time when investors flock to buy gold, finding the stability of gold prices a hedge against both a weakening currency and the possibility of lower bond yields.
Inflationary expectations are running high, despite the recession-like conditions prevailing. Primarily responsible for these sentiments are the easy money policies being followed by most governments, and the Federal Reserve interest rate. The Federal Reserve had slashed its interest rate in 2019 itself; that gold prices began to rise since then is no mere coincidence. When the Federal Reserve fixed the interest rate to zero per cent in March, gold prices only became steeper in their ascent. There are few indications that the rates will be raised any time before 2022, so expectation of inflation on this account is not unfounded. At the same time, national governments have been injecting rounds stimuli into the economy in the form of benefits, rebates and such. They will do much to stead the economy, though a smaller ripple of this has been extremely low bond yields – they are next to zero in the US, and negative in Europe and Japan. The capital has thus been diverted from treasury bonds to the stock market and gold, and silver too.
Betting on the Future
The possibility of a sustainable vaccine at the end of the year is a shining ray of hope in this time of darkness. One can argue that such a possibility may not put a halt to gold’s ascent, as people’s expectation of inflation will not remain the same, if they don’t actually grow more. However, a promising future also means more investments into productive assets, which can lead to a flight of capital from gold speculation. Evidence to support this claim can be drawn from a recent incident – Russia’s approval of the world’s first vaccine led to a rise in the global stock markets trade, while gold prices also saw a dip. Both the rise in the stock markets and the dip in gold were small, but this just mirrored the lack of trust in the vaccine’s efficacy. With the development of more vaccines, the picture could be much brighter.
Let us hope this is the case, for gold is, and should remain, a temporary precautionary investment. In the larger scheme of things, wealth should be poured into those assets that will eventually steer the economy forward, an ability that gold does not possess.
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