The price of gold has been a big story this summer with spot prices recently reaching over $1500 per ounce, which is a six-year high. In 2019 gold has gone up $295 per ounce, or 24.37%, and in the past month alone it is up $97, or 6.9% (as of August 8, 2019). Silver is also up substantially, especially in percentage terms.
Gold has often been presented as a hedge against inflation, but while that has been the case at certain times such as in the late 1970s, today – with inflation continuing to remain low for now -- the yellow metal is seen mainly as a hedge against economic and geopolitical uncertainty as well as currency depreciation.
It is also a hedge against declining bond yields, which have been negative in Europe for several years. There is currently $15 trillion in debt that pays a negative yield (meaning bond holders are paying banks to hold their money). Gold tends to perform well when real interest rates (factoring in inflation) are low because there is no opportunity cost to owning gold when assets like bonds pay little or no yield.
2019 Gold Trends
In 2019 as the world economy has slowed and trade tensions between the two largest economies – the U.S. and China – have increased, stock markets around the world experienced higher volatility. That was especially the case at the beginning of August after the Chinese let their Yuan currency be devalued after the Trump administration threatened to impose a new round of tariffs in September. China is heavily reliant on exports, and a cheaper currency makes its goods cheaper to import.
Meanwhile, around the world geopolitical tensions are on the rise such as in the Middle East where the potential for military confrontation between the U.S. and Iran has increased; mass demonstrations in Hong Kong could lead to more repressive measures by the Chinese government; and the United Kingdom may crash out of the European Union at the end of October without a deal. Remember that the 2016 UK vote to leave the EU resulted in a temporary sharp spike in gold prices.
In the face of those economic and geopolitical trends, some are flocking to gold. Retail demand, although strong, is dwarfed by increased flows to gold Exchange Traded Funds (at a 6-year high) and massive gold purchases by central banks around the world (at an all-time high), which are looking to diversify their assets by reducing the amount of dollars they hold.
So how does today’s bullish gold market compare with previous periods when many were bullish on gold? The two periods of greatest relevance are 1980, when gold reached $850 per ounce, which when adjusted for inflation is higher than any level reached since then, and 2011, when gold hit its all-time nominal high of $1918 per ounce in late August*.
1980: gold bubble bursts
In 1980 the U.S. economy began a severe recession that lasted two years and saw sharply higher unemployment levels. Geopolitical tensions rose following the Soviet invasion of Afghanistan in December 1979 and the Iran hostage crisis that began in November of that year. In addition, inflation had reached 13% by December 1979, which led the Federal Reserve to increase interest rates from 13% to 20% to try to stem inflation. Finally, the silver market was being manipulated by the Hunt Brothers, pushing prices to $50 per ounce in a short period, which also contributed to gold’s spike. However, when the brothers could not meet margin calls, a group of U.S. banks provided over $1 billion in credit to prevent markets from collapsing.
It is also important to remember that during this period, classic bubble aspects were pervasive in the sharp and quick rise of gold and silver prices. As word spread of these increases, there was an atmosphere of frenzy in precious metal markets. Anyone who owned gold or silver tried to cash in, and many common numismatic coins were melted.
It was not long after reaching their 1980 highs that silver and gold came back down to earth. While the rise in geopolitical tensions does have a degree of similarity to today’s situation, the world is not on edge to the degree it was then. Economic conditions in the U.S. are much stronger than they were then, and owners of gold today are less likely to sell than back in 1980 because they expect higher prices in the future.
2011: debt and fiscal issues put drag on economies
From 2009 until late August-early September 2011 gold essentially doubled from $1000 per ounce to just shy of $2000. While the rapid increase in spot might resemble 1980, the situation was mostly different. That is because it was mainly driven by rising debt problems in the U.S. and Europe that were largely a consequence of the 2008 financial crisis.
Within the eurozone many major banks were close to collapsing, which could have precipitated another global economic crisis. In the U.S. the Federal deficit and debt were increasing because of lower tax receipts due to the economic crisis and steps taken to get out of the economic crisis (such as the bank bailout) that led to increased federal spending. There also were concerns about the value of the U.S. dollar declining and about currency market volatility.
Gold prices had already risen sharply in April to over $1500 per ounce after the Federal Reserve announced it would end its quantitative easing program in June, which led some to fear that meant inflation was rising. Then during the summer, the Obama administration and the GOP-led Congress were at an impasse about increasing the debt ceiling, which could have resulted in the first-ever default by the federal government on its obligations.
This situation led to a reduction in the credit rating of the U.S. – a step that resulted in increased costs to service the massive Federal debt. It was while these events were occurring that gold reached its all-time, non-inflation adjusted dollar high over $1900. In addition, that August stock markets dropped sharply as fears increased that the European sovereign debt crisis would spread, sending many to gold at that time.
The main lessons from comparing current trends with those of the two major bullish periods in gold prices are that when the world believes uncertainty will continue to rise – typically due to some combination of domestic and international economic conditions and geopolitical issues – they flock to the perceived safety of gold. But what makes the current situation different from previous bullish eras is that investor demand for gold is underpinned by a decade of central bank gold buying, which recently reached a record and saw Russia become the world’s biggest gold buyer. In fact, central bank gold purchases are up 47% in 2019 compared to the previous year.
Of course, no one knows what will happen next, but the rising price of gold today is a strong signal that many believe we are headed for increased economic uncertainty and disruption combined with continued low interest rates, negative rates in some countries and global currencies depreciating against each other.
*On August 2, 2019 when gold hit $1450 per ounce, it reached an all-time high in 72 currencies other than the dollar all around the world, including the British pound, Australian dollar and Canadian dollar.
“Gold's Dramatic Rise and Fall in 1980s - Why It's Important,” www.seekingalpha.com, March 19, 2010
Kimberly Amadeo, “Gold Prices and the U.S. Economy,” www.thebalance.com, January 13, 2019
“Gold Demand Trends Q2,” World Gold Council (www.gold.org), August 1, 2019
Ross Norman, “Gold Hits All-Time High in 72 Currencies,” www.sharpspixley.com, August 2, 2019
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