Comment

Gold is once more the glittering prize

I am happy to have a small proportion of a well-diversified portfolio sheltered in this traditional port in the storm

There are few advantages to getting older. But one undeniable plus is the perspective it provides. This is particularly important for investors because while market history does not repeat itself, it certainly rhymes.

The surge in the gold price this year has been notable, but it is far from unprecedented. Between 2008 and 2011, gold doubled as investors weighed up a sluggish recovery from the financial crisis and the then-unfamiliar sight of central banks hosing the markets with cash. The stagflation fears which that combination generated came to nothing, however, and gold soon lost its lustre.

Having doubled over the past five years again, the rise and fall of gold a decade ago provides one template for what might happen next. But it is possibly not the best guide to what could unfold. For those with a longer-term perspective, the key year to understanding where gold goes from here is 1979. Looking back over the world’s post-war history, that was the pivotal year on so many fronts and it is no coincidence that it was the last time that the gold price went into the stratosphere.

Before we go back to my O-level year, however, it’s worth looking at the short-term reasons why gold is rising. They are important, even if they only tell part of the story.

The first reason for gold’s rise is the recent weakness in the dollar, as investors focus on the prospect of lower growth in the US. A lower dollar is good news for the gold price because it reduces the cost of the metal to buyers around the world who need fewer pounds, yen or euros to buy the same weight of bullion.

The knock-on impact of the economic fragility that is undermining the dollar is lower interest rates and bond yields. These too support the gold price because they reduce the opportunity cost of holding a non-income-generating asset like gold. When you can earn a decent income from relatively safe financial assets like bonds or even a deposit account, gold is less attractive. If the alternatives are also yield-free, then gold looks a lot more interesting.

And it is not just the absolute level of alternative income streams that matters. If the perception increases that inflation is back on the radar, then the real, price-adjusted value of a bond’s coupon, is reduced yet further. It might, as now, even turn negative, making gold’s zero return look positively generous. Now, clearly, inflation is not a problem today, but the measures employed by governments and central banks to support economies through the pandemic are a step into the unknown. Inflation could well be a big problem tomorrow.

These factors explain the performance of gold to date. They probably do not provide a reason for it to continue rising. Indeed, for that to happen we would need to see a move further into negative territory for real bond yields. And that would require either higher inflation, or lower growth, or both. It is possible, but so too is a repeat of the 2011 scenario in which inflation fails to show up and growth bounces back. That would be a recipe for a sharp retrenchment in the gold price from here.

To make the case for a materially higher gold price from today’s elevated level, you need to go back to that critical year, 1979. And while it isn’t necessary to go fully down the “guns and tinned goods in the backwoods of Idaho” path, you do need to entertain the idea that the events of 2016 to 2020, Brexit to Trump to Covid-19, actually changed everything.

Between December 1978 and January 1980, the price of gold more than quadrupled from under $200 an ounce to more than $800. This is the equivalent of a rise from the $1,200 an ounce at which gold traded last September to around $5,000.

Agonising about whether you have missed the gold and silver boat at today’s record high of just over $2,000 will seem ludicrous if we get a rerun of 1979’s flight to safety. It is not hard to see why investors were so unsettled in 1979. The election of Margaret Thatcher in Britain and the appointment of Paul Volcker as chairman of the Federal Reserve that year marked a sea-change in the post-war consensus about how to manage the global economy.

The modest rise in the Dow on the day that Volcker arrived at the Fed was greeted by one prescient commentator at the time as “like throwing a party to celebrate the arrival of your executioner”. Actually, he turned out to be a kind of saviour, but that is another story.

And 1979 was not just a transatlantic or macro-economic turning point. Kim Ghattas’s magnificent history of the Saudi-Iranian rivalry that has shaped the modern world, Black Wave, points to 1979 as being the watershed year, with the Iranian revolution, the siege of the Holy Mosque in Mecca by Saudi zealots and the Soviet invasion of Afghanistan sowing the seeds of 40 years and counting of misery in the Middle East. The year 1979 laid the foundations for today’s geopolitics.

Is 2020 the new 1979? It is of course a different situation, but the scale of change unleashed by the emergence of a new economic cold war between the US and China, the rise over the past four years of anti-globalist populism all over the world, and the complete reshaping of how we lead our lives and pay for the new social contract in the wake of the pandemic, mark this year as its rival in significance.

I do not know whether gold halves or doubles from here, but I suspect it will be one or the other. And given the higher probability I would assign to the latter, I am happy to have a small proportion of a well-diversified portfolio sheltered in this traditional port in the storm.

Tom Stevenson is an investment director at Fidelity International. The views are his own. He tweets at @tomstevenson63.

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