Why Gold Will Rise
Jun 20, 2022 04:30 PM EDT
Gold's tepid response to rising inflation has shaken the conviction of many investors. Despite the country witnessing its highest inflation levels in 40 years, the World Bank's stark warning of 1970s-style stagflation, and the bond and equity markets struggling, gold has performed tepidly. This goes counter to what we know about gold: in the 1970s, when the world last experienced stagflation, gold rose 1000% over the decade, ending it as the best performing asset class.
As the chart below shows, despite all the ingredients for a traditional gold rally, gold has barely risen since the start of the year. If you bought gold at the start of the year, you basically compounded your investment at 0.8% per month.
(Photo : World Gold Council)
On a real-basis, given rising inflation, investors have lost money from their investment. What has made this even more puzzling for investors is that other real assets have responded to rising inflation with asset price appreciation. Indeed, what is inflation if not the rise in prices of real assets? The totemic real asset, gold, has simply refused to go up. Given that gold has a low correlation with bonds and equities, you would think that investors would have diversified into gold. So what's happening?
The U.S. Dollar Has Proven Resilient
Across the world, inflation is rising. In India, which is the gold jewellery market's biggest market, inflation is nearing 7.8%, compared to some 8.5% in the United States. Investors and central banks have responded by buying U.S. dollars, and this has given the dollar enormous strength in recent months. Gold, which is quoted in U.S. dollars, has simply become cheaper as a result of the dollar becoming stronger. The U.S. Dollar Index has compounded by 1.74% per month since the start of the year.
(Photo : MarketWatch)
U.S. Treasury yields have risen as the market bakes in expectations of future interest rate hikes. We are likely to see gold in a tepid zone as the dollar strengthens.
A Unique Buying Opportunity
However, in the long run, the present situation gives investors a unique buying opportunity. Good investors know that when a quality asset becomes cheaper, that is an investment opportunity. One way to frame this is by looking at the Dow-Gold ratio. The higher the ratio, the cheaper gold is. Historically, this has proven true, with the gold price subsequently rising.
(Photo : Macrotrends)
The chart below shows you how the gold price has performed over the last century.
(Photo : Macrotrends)
As you can see, the 1960s, when the ratio was high, was followed by the 1970s, when the price took off.
An asset cannot permanently rise in value. At some point, the dollar and U.S. Treasuries will become unattractive and investors and central banks will turn to gold to protect them from what is likely to be long-term inflation. Investors can get exposure to gold by buying physical-gold, gold exchange-traded funds (ETFs), stocks in gold miners and explorers, and getting a gold IRA account. This will position investors for gold's rally. You want to buy when gold is cheap to make big profits.
