Everyone has noticed the gold boom by now. But nobody can agree on why the gold price is flying.
It’s dangerously easy to read your favourite narrative into market action. Especially with gold. And especially when it’s going up, fast.
The price is up almost 50% since October 2022, and 21% in the last six months alone.
Over the last three months, gold outperformed all major Western stockmarket indices. And back in January, before the surge in gold even began in earnest, it was running ahead of the S&P500 since the turn of the 21st century!
Lately, the gold price has even outperformed bitcoin.
Put together, it’s enough to make gold bugs believe they were right all along.
But why is the gold price going up? Everyone has their own theory. There are countless articles explaining it. And everyone is convinced they’ve got it right.
But I’m not so sure any of the arguments are conclusive…
The ‘real’ reason for gold’s surge
The obvious explanation is inflation. It’s proving difficult to slay. In some countries, the rate of inflation is outright rising. Producer price indices and other measures like oil are suggesting there’s plenty more to come.
Gold preserves purchasing power over long periods of time. And so investors worried about inflation can protect themselves by buying more of it. As they do, the gold price goes up.
But gold is not the only inflation hedge out there. And it didn’t surge when inflation broke out in 2021. Nor when it surged out of control in 2022. Something else must have changed.
A savvy version of this argument points to ‘real yields’. These are interest rates adjusted for inflation.
If inflaiton is rising, then the true rate of return you’re getting from earning interest is falling. If inflation is higher than the interest rates you’re earning, then you’re actually losing money. Well, you’re losing purchasing power.
This is not a great place to be. And so investors avoid interest bearing investments like bonds when real yields are negative. What might they buy instead? Gold!
But real rates remain positive. And the gold price didn’t surge when real yields went negative in 2021 and 2022. Not like it is surging now.
Inflation — was it murder or manslaughter?
What if governments and central banks deliberately staged the inflationary outburst of 2021? And the negative real yields that followed as well?
Such a policy is known as ‘financial repression’. The idea is to inflate away the government debt. By keeping inflation above government bond yields, the debt becomes worth less over time.
If this was a deliberate policy, then we may face the same thing for a prolonged period. Inflation may spend a decade peeking above interest rates until debt to GDP ratios are brought back to more sustainable levels.
In that environment, gold is a great asset to own and bonds are disastrous. So perhaps people are realising the inflaiton spikes of 2021 and 2022 were just the beginning.
The prospects for gold are even better if the financial repression goes wrong. If inflation surges too high, people will lose faith in the currency. They’ll buy gold to protect themselves. That’s why unusual sources of gold sales like Costco are currently doing a roaring business in the yellow metal.
But why didn’t gold go up in 2021 then?
Blame the Russians and the Chinese
Geopolitics is another popular explanation for gold’s surge. The world is growing ever riskier. Governments are fighting it out in the financial sphere as well as on the battlefield. Gold is one way to opt out of this risk.
The US Congress recently voted to confiscate Russian assets to pay for the war in Ukraine. This has helped everyone realise that their property is only their own for as long as the Americans regard it as such.
Gold is one of the very few assets which has no counterparty risk. If you hold it in your possession, that is. The theory is that governments which don’t want to be at the mercy of the West’s ability to confiscate their assets are shifting into gold to reduce the risk. The likes of Russia and China are buying to shift their wealth out of America’s reach.
But the gold price didn’t surge at the outbreak of geopolitical tensions. It didn’t break out of its multi-year range when Russia invaded Ukraine. Nor when the conflict in Gaza began. It looks to me like the gold price took a break from its surge when Iran entered the conflict directly by launching an attack on Israel.
Another angle is that Chinese investors seeking to escape their country’s property bust are piling into gold. Or that the Shanghai gold market is wrestling control of the gold price from New York and London.
But none of this is new. Why is the gold price surging now.
Conspiracy theories no longer
Governments and central banks still hold a lot of gold. Not so long ago, they claimed this was merely as a remnant of the bygone gold standard era. But what if that’s no longer true?
Over the last year, more and more mainstream institutions have come out in favour of gold’s role in the monetary system. And some have begun to speculate about a peculiar policy move that was dismissed as an absurd conspiracy theory not so long ago.
The gold held by governments and central banks is not held at market value. A lot of it is valued at US$35 an ounce, for example.
A revaluation to reflect the current price of gold would mean a vast capital gain for governments and central banks. Something that could make their precarious financial situation look a lot better.
The argument of conspiracy theorists is that governments and central banks are preparing to do this. They will announce the revaluation of their reserves to market prices, or even higher ones. This would be an admission of gold’s role in the monetary system as the bedrock upon which money is based.
The higher the gold price at revaluation, the better central banks and governments will look. The resulting attention this would draw is also likely to push the gold price up.
But it would also be an admission that central banks need gold because they can’t manage the financial system properly. And I can’t see that coming.
Who’s right about gold?
I don’t know which argument for gold’s rise holds water. There are plenty I haven’t mentioned here.
My own theory is that the 9 o’clock gold slam has stopped. Without this downward pressure, the gold price is finding it easier to break out. But even that explanation is not quite enough to explain the surge.
Perhaps it’s a combination of all of the above.
But here’s what we do know. When commodities break out of long-term trading ranges like gold has been in, they tend to spike dramatically higher over time.
And when gold surges, gold stocks respond. Well, the right ones do. So, how do you find them? That part’s easy…well, my friend Brian has made it easy for you.
Until next time,
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Nick Hubble,
Editor, Strategic Intelligence Australia
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