Historically, gold has had a negative correlation with stocks and other financial instruments. Does the current combined loss of financial assets herald a new golden age?
According to data from 1990, this quarter is expected to record the largest combined loss for global bonds and equities. In this context, could gold return as a safe haven? While it doesn’t generate income like stocks and bonds, the price of an ounce of fine gold (31 grams) has fallen sharply since January 1stah January 2022 when the S&P 500 lost 22% and the Nasdaq lost over 31%. Previously, between January and August 2020, during the historic global recession caused by the Covid-19 pandemic, the price of gold had risen by more than 20%.
Gold keeps its safe haven in times of financial uncertainty, but also in geopolitical crises. It is often referred to as a “crisis commodity” because it often outperforms other assets in these environments. However, it is also worth considering its hedging abilities and its relationship to inflation, central banks or Bitcoin.
What is the relationship between gold and inflation?
Inflation has become one of the top concerns for investors. The arguments for “uncomfortably high” US inflation appear to outweigh the arguments against in the near term. Gold is a proven long-term hedge against inflation, but its near-term performance is less compelling. According to Reuters calculations, since 1971, gold returns and changes in CPI have historically had a weak linear relationship, only 16% of gold price change can be explained by changes in CPI. While a period from the 1970s to the early 1980s saw both strong gold returns and extremely high inflation, this situation has not repeated since, partly because inflation was much weaker and partly because the relationship between gold and the CPI was weaker. In fact, since the early 1980s, the only sustained period of “uncomfortably” high CPI inflation (+4%) amid good gold returns was from Q4 2007 to Q2 2008, at the height of the Global Financial Crisis (GFC). This inconclusive linear relationship does not preclude the use of gold as a hedge. Rather, it simply suggests that US CPI is often not enough to push gold prices up or down. Gold is not the only inflation hedge, suggesting that there should be a link between gold’s inflation sensitivity and investors’ access to other forms of inflation protection – such as central bank policy or access to financial or physical assets.
The current market turbulence speaks for “safe havens”. Gold is one of them.
Gold’s strongest attribute is its contribution to a portfolio, although gold is a somewhat blunt tool when it comes to inflation. However, when it is added to a selection of assets, its performance begins to improve. In short, gold’s ability to protect itself from more than an increase in the broader price level suggests that its real long-term returns should be positive — something that current long-term portfolios may struggle to match.
Central banks love it
According to a World Gold Council (WGC) survey, central banks view gold as a reserve asset and are likely to increase their holdings of the metal over the next 12 months. This is mainly due to growing concerns about a possible global financial crisis. This is up from 21% in 2021. Expected changes in the international monetary system and concerns about rising economic risks in reserve currency economies are also important factors, according to the report.
Add to this rising inflation, monetary tightening and Russia’s war in Ukraine, which are further disrupting supply chains and bringing geopolitical uncertainty. The survey also found that a majority of central banks believe that gold’s share of total reserves will increase over the next few years, that its safe-haven properties and ability to hold its own in times of crisis remain influential. In detail, global central banks’ gold reserves rose 19.4 tons in April, returning to net purchases after net sales of 9.4 tons in March. Uzbekistan was the biggest buyer during the month, adding 8.7 tons to its gold reserves. Turkey continued its gold purchases this year, buying an additional 5.6t during the month, while Kazakhstan bought 5.3t during the month. Sales were dominated by Germany, which sold 0.9t in April, while Mexico and the Czech Republic each sold 0.1t.
A necessary diversification factor
The key to diversification is to find investments that are not highly correlated with each other. Historically, gold has had a negative correlation with stocks and other financial instruments. Recent history confirms this. The 1970s were great for gold but terrible for stocks, just like 2008. The 1980s and 1990s were great for stocks but terrible for gold.
Well-diversified investors combine gold with stocks and bonds in a portfolio to reduce overall volatility and risk. This is because the price of gold rises in response to events that cause the value of paper assets like stocks and bonds to fall. Although the price of gold can be volatile in the short term, it has always held its value over the long term. Over the years, it has served as a hedge against inflation and the erosion of major currencies.
Cryptocurrency Falls: The Return to Gold?
Amid the demise of cryptocurrencies, institutional investors are gradually turning away from bitcoin and back to gold for the first time since the beginning of the year. The combination of rising inflation, tighter regulations, environmental issues, and impact on the crypto community has sent bitcoin prices plummeting over the past few weeks. It has lost around two-thirds of its value since its April record of $65,000. Bitcoin flow chart continues to deteriorate, suggesting a continued pullback from institutional investors. Momentum traders, including crypto funds that have recently liquidated their assets, are partly to blame. Notably, recent Bitcoin outflows have been accompanied by inflows into gold ETFs, in a trend reversal from the last quarter of 2020 and early 2021. A similar pattern can be seen in futures contracts on both assets.
The current market turbulence speaks for “safe havens”. Gold is one of them. However, these are not its only qualities and investors should take a closer look soon…