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Why has the gold price hit a record high – and what could it mean for the economy?

Analysis: What could this mass gold buying activity be saying about the expectations about the global economy in the midst of the coronavirus pandemic? Ben Chu investigates

Thursday 06 August 2020 08:16 EDT
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Gold is traditionally seen as a “safe haven” asset, meaning people that tend to buy it when there is economic and financial stress taking place in the wider economy
Gold is traditionally seen as a “safe haven” asset, meaning people that tend to buy it when there is economic and financial stress taking place in the wider economy (AFP via Getty Images)

The price of an ounce of gold passed $2,000 this week, the highest traded price ever seen for the precious metal.

The jump in price reflects the fact that many short-term speculators and also long-term investors around the world have been ploughing money into gold on a huge scale.

But why would they be doing so? Is this a wise investment? Or could it be a bubble?

And what could this mass gold buying activity be saying about the expectations about the global economy in the midst of the coronavirus pandemic?

What’s actually happening in gold markets?

When we think of people buying gold we probably have an image of someone buying a gold bar or perhaps jewellery. But, in fact, much of the investment in gold in modern markets is done through financial derivatives.

Many investors and speculators have been “buying gold” by buying shares in so-called Exchange Traded Funds (ETF), where the value of each unit is linked to the trade price of gold.

One major gold ETF, SPDR Gold Shares, run by a US bank and the World Gold Council, now owns, on behalf of investors, 1,258 tonnes of gold. That’s higher than that amount of gold owned by some central banks around the world such as Japan and India according to calculations by the Financial Times.

Is this really the highest price that gold has ever been?

In terms of the US dollar face value of an ounce of gold it has never been higher than it is today, having passed its previous peak in 2011.

But a dollar today buys less than it did in the past due to inflation.

If one adjusts the dollar price of gold for dollar inflation the price of an ounce of gold was actually highest in January 1980 – at $2,500 – according to the World Gold Council.

Why would people invest in gold?

On the face of it, gold is not much of an investment. Unlike investments in “productive” assets such as growing companies it doesn’t pay an income to the owner in the form of dividends.

And unlike investments in debt, whether issued by firms or governments, it doesn’t pay interest.

Further, for those who invest in physical quantities of the metal, they have to pay for secure storage.

On the other hand, gold has an enduring desirability to humans, shown through their willingness to pay to own it for millennia.

Thus gold has proven itself as a store of value.

But why would people be buying gold now?

Gold is traditionally seen as a “safe haven” asset, meaning people that tend to buy it when there is economic and financial stress taking place in the wider economy.

When company share prices are falling rapidly gold is often popular. The argument is that people feel confident that gold, at least, will retain its value.

That explanation is problematic however. There is certainly huge stress in the global economy, but the surge in gold has come as share prices have been recovering from their lows in March.

Some suggest that gold is an effective hedge against inflation and that the surge of gold buying now reflects that to some extent.

The analysis here is that central banks have printed unprecedented amounts of money to support their economies in this pandemic – and governments have taken on large amounts of extra debt – and that this will, in the end, result in a surge of prices in developed economies like the US and Europe.

How credible is that explanation?

While it’s not impossible a burst of inflation will follow the Covid crisis many analysts point out that this would require governments to override the independence of their central banks, which have a clear mandate to keep inflation under control.

That would be a considerable institutional obstacle to inflation taking off.

Furthermore it’s notable that though the price of inflation-protected government bonds has recently signalled an increase in inflation expectations from investors the price movements do not point to a 1970s-style surge in prices.

The implied inflation rate for the US in ten years’ time is currently still just 1.57 per cent.

To put it bluntly, if a major bout of inflation is around the corner bond market investors will have to be badly wrong.

Another reason to put your money in an asset like gold is simpler: you expect its value to go up.

If enough people think along these lines you can get rapid increases with no underlying justification. It’s entirely possible that recent surge in gold prices merely represents a speculative bubble.

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