When Gold Does Well
Gold is essentially a ‘risk-off’ asset. Investors turn to gold for safety when they perceive that risks are rising including financial, economic and currency risks as well as political risks affecting ownership rights such as expropriation, a capital controls and increased taxation. In general, greater instability equals a higher gold price.
Here are the environments that have historically supported gold bull markets:
- Investors are losing confidence that central banks and governments have everything under control.
- Markets for financial assets, especially equities, are falling and investors are looking for safety.
- Investors are worried about rising credit stress and the threat of defaults.
- The Federal Reserve is perceived to be “behind the curve”. Price and wage inflation is rising faster than the Fed is raising short term interest rates.
- Stagflation: Real economic growth (after inflation) is rising more slowly than the rate of price inflation.
Gold Does Poorly in These Environments
- Real economic growth (after inflation) is strong and the rate of inflation is moderate by comparison. An extended periods of disinflation (1980 to 2000 is a perfect example) is particularly challenging to gold. The rate of inflation gradually falls while economic growth is good. Who needs gold? The result was a 20 year bear market in gold.
- Confidence is high that central banks will be able to keep things under control. For example, markets were confident in 2012 that Federal Reserve Chairman Ben Bernanke’s monetary policy would stimulate economic growth and that European Central Bank Chairman Mario Draghi’s promise in 2012 to do “whatever it takes” would resolve Europe’s financial, economic and political problems. Gold entered a bear market after reaching an all-time record in 2011.