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Golden days of yore

Tue, 09/20/2022 - 15:05

For millennia, gold has been prized as a store of value. It was made into jewellery, ornaments, bars and coins, and until the mid-20th century, many of the world's biggest economies used it to back their national currencies. But why did and do we hold this yellow metal in such high esteem? Apart from being malleable and pretty to look at, the practical uses of gold and silver were only discovered well after the Industrial Revolution. Nonetheless, culture after culture has mined, hoarded and gone to war over it.

Nobody really knows exactly why gold and silver are considered so precious. They might well have little inherent value, but they have been able to match inflation throughout much of recorded human history, which is quite a feat in itself. This makes them a wise consideration for anyone looking to put together a balanced investment portfolio, particularly during times of economic uncertainty and high inflation, such as we are currently experiencing. The tricky bit is how to decide on a sound weighting for the specific financial environment and how to spot a trend reversal in time.

A short trip down memory lane

For many traders and investors at their peak today, the pain of the 2007-08 global financial crisis (GFC) is just as vivid now as it was at the time. We will all have seen how apparently safe-bet investments were wiped out over a very short period of time, causing unspeakable economic hardship for countless people. 

However, there was one asset class that absolutely exploded in the wake of the GFC, and that was gold. As stocks and bonds burned, the yellow metal rose from $500 an ounce in early 2007 to a peak of $1800 in late 2011. Steady gains of 100% per year are thought of as unusual, even in revolutionary growth stocks, but it's a total anomaly for commodities. Having seen how well XAU/USD did in these recent crisis times, most investors and even some traders are convinced that their allocations should be increased during Black Swan events and periods of hyperinflation.

No time like the present

The pandemic and subsequent financial insecurity have now given us a more recent crisis against which to measure precious metals' performance, and the results of this analysis show the vital importance of wider context. Gold started 2020 at around $1550, while silver began the same year at just $18 an ounce. Both managed to make strong gains above 30% over the initial pandemic period but have now settled down to somewhere around 10% higher than their January 2020 levels.

Given the complete novelty of the coronavirus crisis, these sub-inflation increases appear extremely underwhelming. When we look a little closer, though, we see just how many factors are at play. In this crisis, the entire world stopped functioning, which inevitably meant less industrial demand for these metals. Second, ultra-low interest rates and active quantitative easing by central banks meant that stocks and crypto were much more attractive to a new breed of investors. Now, as interest rates rise, other 'safe havens' like US Treasury bonds and the US dollar itself are taking increasingly more capital away from 'unfashionable' precious metals.

Back to the future

As we have already touched upon, gold has traditionally performed exceptionally well during times of high inflation and economic uncertainty. However, the past year or two have been less than impressive, given the circumstances. Though the causes are multiple, interest rates have certainly played a role. The ultra-dovish climate leading into this crisis meant that, as the US Federal Reserve began sharply increasing interest rates, the dollar strengthened rapidly against virtually all the majors. Naturally, the US dollar is a safe harbour in itself and one that is much more liquid than gold or silver.

The view many investors took was that it is better to have USD on hand to buy more assets when prices crash than to park it all in precious metals, particularly when the greenback is more or less outperforming inflation for anyone outside the US. Yet, if inflation proves much less transitory than first believed, we could well see demand for gold increase steadily. Numerous pundits had predicted that the latest inflation data would show a significant retreat in price pressure. But now that this dream has been well and truly dashed, we could soon see stable inflows into gold and silver.

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