Gold is Money, Everything Else is Credit.

Question of the week: If gold is an inflation hedge, why did it fail to perform well last year when inflation was rampant? And if inflation is receding now, why is gold now approaching new all-time highs?

Bloomberg Markets Live produced an article this week answering that question; here is our summary. The correlation between gold prices and CPI is about zero over the long term, meaning that there appears to be no immediate, direct relationship at all between inflation and gold prices. (Although over the long run, gold has been an excellent inflation hedge. To re-use and old story, in 1930, a kilo of gold would buy you a new Chevy. Today a kilo of gold will buy you… a new Chevy.)

However, there does appear to be a relationship between gold prices and real interest rates (that is, interest rates less the inflation rate). As shown below, gold returns have historically been strongest when real yields are between -2% to +2%. Real yields are currently about -1% (blue bar).

The Bloomberg story continues, saying that CPI fixing swaps and the current level of Fed rates show that the spot real rate is expected to be between 1% and 2% for most of the rest of this year. (See chart below.) If that holds, it implies gold will be in the sweet spot for a strong performance this year. As always, past returns are no assurance of future returns, but at least history is on your side.

Aside from that historical perspective, gold buying by Central Banks has been very high with 2022 purchases the highest on record. We have every expectation that trend will continue this year. As the world splits between East and West, and the East desires some insulation from Western sanctions/policies, there is a natural trend for Eastern central banks to sell treasuries and buy gold and begin to limit the use of the US dollar for international transactions. In recent weeks China and Saudi Arabia, among others, have initiated large trading transactions in local currencies, circumventing the dollar-based system used for many years. With little prospect of a reconciliation between East and West, it is hard to envision this trend reversing anytime soon.

The bottom line is that the fundamentals for gold are strong. As we hope you know, we hold gold in all PWM models. Gold is generally not correlated to other asset classes and is therefore a strong portfolio diversifier. But it also plays another important role, which is as an ‘insurance policy’ against the decline of fiat currencies. The gold standard may be long gone, but as long as central banks own gold as reserves, then gold remains money. As J.P. Morgan said, Gold is money, everything else is credit.

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The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

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By: Adam