There’s no avoiding the fact that the gold price fell, down about US$15 an ounce since the end of last week to trade around US$1,700/oz at the time of writing.
But that 0.8% fall looks good alongside a 4.6% drop in the US stock market as measured by the S&P 500, and 4.2% by the Dow Jones Industrial Average which tracks the top 30 stocks – and Australia’s sharp fall on Wednesday which followed the US rout.
Gold’s better performance than the overall market is a sign that the precious metal is attracting safe haven investors concerned that equity markets have further to drop as the US central bank persists with its attack on inflation.
Investors outside the US are particularly keen on gold as the value of the metal is propelled higher in their currencies thanks to a rise in the value of the US dollar.
Australia is a case study with the price of gold in Australian dollars rising by A$21/oz this week to A$2,528/oz even as the US dollar price fell – a function of currency shifts being driven by rising US interest rates.
In Europe and Japan, the performance of gold has been even more impressive as the Euro and Yen decline against the US dollar. In Euro terms, gold is up 7%, while in Yen it is 17% higher.
As the US Federal Reserve increases interest rates, with another 0.75% hike expected later this month, the US dollar is likely to inch upwards – adding the downward pressure on all asset classes.
In normal times, a stronger US dollar and higher US interest rates would be bad news for gold, and the metal is likely to be bruised as interest rates move up, but more damage can be expected in the broader equity market.
Gold, over the next 12-months is likely to play one of its oldest roles, as a sheet-anchor in a stormy sea – an asset class in its own right.
What happened on financial markets this week should not have taken investors by surprise because they have been warned for decades about the risk of ignoring the policies of the US Federal Reserve (or Fed to use its nickname).
“Don’t fight the Fed” is advice which was disregarded by investors who have flocked back into the stock market after each central bank interest rate increase, effectively telling the bank that higher rates are not a problem.
Each upward move in equity prices, including a 6% rise in US share prices over the first 13 days of this month, is a red flag to the rate setters at the Fed who want to see prices falling and a normalisation of equity values.
So, when US inflation came in at an annualised 8.3% for August, a collective shudder ran through financial markets with hopes for the next rate rise being a modest 0.5% dashed, to be replaced by another mega-move of 0.75% and perhaps a killer blow of a full 1%.
What particularly concerns investment banks and explains their gloomier view of where interest rates might be heading is a growing belief that inflation is more deeply embedded in the US economy than has been previously been believed
Nomura, a Japanese bank, said in a research note after the release of the latest inflation data that it believed financial markets “underappreciate just how entrenched US inflation has become and the magnitude of the response that will likely be required to dislodge it.”
As well as another 0.75% rise in rates as early as next week the overall increase over the next three months is expected to be 1.75% with the ultimate objective being to lift rates back to 4.25%.
For investors with a taste for gold what appears to be happening is a recognition that it will be a winner when the Fed finally achieves its objective, the death of inflation, even at the price of tipping the world into a recession.
Mike McGlone, senior commodity strategist at Bloomberg Intelligence, wrote this week that the next rally in the gold price could depend on how quickly the Fed can deflate the stock market.
It’s possible, McGlone wrote, that “an elongated period of gold’s underperformance and stock market outperformance may be reversing”.
“This narrative from the year 2000 is gaining traction in 2022. The metal is down about 6% versus about a 15% decline in the S&P 500 to 9 September.
“The tendency for the Fed to hike rates until something breaks may be nearing an inflection point in currencies, with implications for gold.”
McGlone wrote that with most central banks raising interest rates to fight inflation a parallel can be drawn with what happened in 2008 after economic growth slowed in the wake of the global financial crisis.
Then, gold in 2008 bottomed at around US$700/oz before beginning a long rise to US$1,700/oz in 2011.
McGlone’s theory is that a bottom for gold could coincide with a bottom in global economic growth.
“And that could usher in the next big rally,” he wrote.
The fact that gold has not been sold off harshly like other asset classes this week could be a sign that investors are taking early positions in gold ahead of the Fed winning the fight against inflation albeit at the cost of recession.