With ongoing pressures to keep economies moving during the coronavirus pandemic, policymakers are doing almost everything possible to continue to encourage spending; for example, offering zero interest rates and printing cash. The measures, with their inherent propensity for inflation, have caused many investors to return to gold as a safe haven and hedge against currency devaluation as it has done during previous terms of economic distress. In this article, we shine a light on the role the lustrous metal has played so far during the coronavirus pandemic, and compare this to other periods of economic turbulence of the past century to determine whether or not gold is still worth its weight in… well… gold!
Gold rushes in the past
Considered a safe-haven for investment, gold has shone brightly at various times during the last century. For example, it surged during the stagflation of the 1970s, rising sevenfold in value over the course of the decade to a peak of $850/oz at the start of the 1980s. Similarly, it surged again during the financial crisis of 2008, peaking at $1900/oz before sliding back to $1200/oz in 2015. However, this cyclical behaviour has encouraged speculation over the true inflation-adjusted yield of gold over the longer term and earned it the reputation for being a good safe haven in times of distress, but dead weight during periods of growth and prosperity. Indeed, the real inflation-adjusted yield of gold has been only 1.1% per annum over the last century. Compare that to 6.5% for US stocks and even 1.6% for Treasury Bonds (purportedly the most risk-free asset available) during the same time period, 1900 to 2000, and it is tempting to see why the commodity has lost its lustre in the eyes of many investors.
As noted above, gold has routinely been considered a prudent investment in times of distress, whether that be due to natural disaster, conflict, or political turbulence. With Q1 – Q3 of 2020 providing all three in ample measure, it is to no surprise that we have observed an increase in the value of gold from $1,528/oz in January to $1,922/oz in October — an increase of just over 20%. Furthermore, a survey in August 2020 found that one in six Americans had bought gold, or other precious metals, since June, and of those that hadn’t, one in four were “thinking seriously” about doing so in the near future.
Why gold is favoured in the current climate
Since the unilateral adoption of fiat money in the major Western markets, it has become harder to find a truly effective diversifier against the depreciation of paper currencies. However, with interest rates set close to zero in the US and UK, and the supply of paper-backed currencies increasing at a considerable rate, it is becoming increasingly prudent to hedge against the devaluation of paper currencies. So far, the increase in printing from central banks has produced a perhaps surprisingly small amount of inflation (the true cause of currency value erosion), whilst succeeding to bolster financial assets. But, with the pandemic positioned to remain for much longer than first anticipated, this requires the inevitable continuation of printing to encourage spending. Furthermore, the stimulus required in response to the pandemic has been to replace lost income and not just lost credit. Replacing lost income is inherently more inflationary than replacing credit (as in the aftermath of the 2008 financial crisis), since it doesn’t inherently replace the lost supply that the lost incomes were paying for. The risk of inflationary market effects therefore certainly remains high. At the outbreak of the pandemic, the shape of the economic recovery was assumed to take one of a number of forms. A “V-shape” recovery, in the case where the outbreak is controlled quickly and the economy able to bounce back in a short time-frame. A “U-shape” recovery where the initial shock would cause a discernible period of low economic growth, while the number of cases were reduced by lockdown measures and business effectively postponed for a number of months, before a speedy recovery. Or even a rotated “Z-shape” recovery, whereby multiple oscillations between normal activity followed by “circuit breaker” lockdowns would cause a zig-zag shaped recovery, until the virus is totally eradicated. However, at the time of writing, the virus remains in circulation, employment remains at record lows, and with the approaching winter season, the chances of a quick turnaround and recovery seem increasingly unlikely. The likely resulting period of stagflation puts fiscal policymakers in a difficult position; stay too “loose” and risk significant levels of inflation, as seen after WWII or in the 1970s; or, tighten spending too soon and risk initiating another sharp downturn, as seen for example in 1937. Both of these perfectly real possibilities leave paper-currencies and paper-backed assets particularly vulnerable. In contrast to the vulnerability of paper-backed assets, gold, in both cases, emerges stronger.
Gold has the further advantage of not necessarily being tied to any single currency. It would be naive to anticipate that all nations emerge from the pandemic equally and as such, holding a commodity that effectively transcends currency discrepancies could certainly be a wise option.
How this gold rally compares to others
So far, we have sung the praises of gold as an effective way to diversify a portfolio and as a safe haven during times of economic distress. But to gauge whether or not this is reflected in its current value, we should look at previous gold-rushes and determine whether or not the increases in true value align. How does the year-to-date rally of 20% compare to other times of economic distress?
Paper currencies used to be tied to the value of gold, therefore forcing policymakers explicitly to devalue against gold in order to print more currency and encourage spending, for example following the Great Depression of the 1930s and the aftermath of WWII. Between 1932 and 1952, the cumulative appreciative value of gold increased by 102% vs the dollar, but 220% vs the Paper Currency Basket (PCB) as indexed to 1920. The value then remained almost constant, yielding almost zero inflation-adjusted return until the economic shock of the dissolution of the Bretton Woods system in 1971 — which caused the value of gold to increase by 1,127% vs the dollar and 1,132% vs the PCB! Now, in the era of fiat money and without the explicit need to devalue the currency against gold, the overall effect of reflationary policies is to devalue paper currencies relative to commodity-linked storeholds of wealth. Finally, following the global financial crisis of 2008, we saw an increase in the value of gold of 130% against the dollar and 114% against the PCB. With these figures in mind, the recent increase of 20% year-to-date appears particularly modest, despite the value of gold being at an all time high. Of course, comparing the economic shock of the coronavirus pandemic to other periods of economic distress, with fundamentally different causes, should be taken with a pinch of salt. However, many investors are understandably sceptical as to whether gold still poses a sensible investment in Q4 of 2020, since the commodity is currently trading at almost record highs. The comparisons between the behaviour of the precious metal now and its behaviour in the past however, result in the temptation to conclude that there is still plenty of potential value in the yellow bars yet!