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INFLATION IS SURGING, central-bank money-printing has run amok and political tensions between the world’s powers are intensifying. These ingredients sound like a waking fantasy for ardent believers in the long-term promise of gold. Even mainstream investors might have been tempted to increase their holdings of the precious metal. Why then was it unable to eke out even a marginal gain in 2021, recording its worst annual performance in six years?
For conventional investors, valuing gold poses a problem. The precious metal does not generate a stream of income. Since demand for it tends to be speculative, the cash-flow models used to work out whether assets are cheap or expensive cannot be applied.
One measure, however, contains predictive power. Every big move in the price of gold, particularly in the period since the global financial crisis, has been inversely correlated with moves in real interest rates. There are few financial relationships that have held up as well as that between the price of gold and the yield on inflation-protected Treasuries (TIPS). The lower real, safe yields are, the greater the appeal of an asset without a yield that may rise in value.
Part of the explanation for gold’s underwhelming performance last year is that this relationship continued to hold. Despite the frenzy over inflation, ten-year real interest rates began the year at -1.06% and ended at -1.04%. Gold ended 2021 at around $1,822 per troy ounce, practically flat on the year. Over the past decade, though, gold has been the less reliable of the two. If you had simply held the iShares TIPS bond exchange-traded fund in that time you would have made 35%, more than double what you would have earned by holding gold.
Regulation has also dulled the precious metal’s sheen. New rules on bank-funding ratios, as part of the Basel III accord, came into effect in the EU in June and in Britain on January 1st. These consider government bonds to be “high-quality liquid assets”. By contrast, holders of gold, like those of equities, must match 85% of their holdings with funding from stable sources. That makes gold costlier for banks to hold, and puts it at a disadvantage compared with Treasuries. If the yellow metal is simply a less reliable proxy for TIPS, without the friendly regulatory treatment, why bother?
The answer for some investors would once have been clear. Paper money and government-issued bonds are ephemeral, and catastrophic failures of financial systems often stem from overconfidence in their safety. But gold, the argument goes, has stood the test of time. The dollar became America’s national currency only in 1863. People have prized precious metals for millennia.
Yet gold’s status as the final line of defence against currency mismanagement is also being contested. Cryptocurrencies, particularly bitcoin, are increasingly found in more mainstream portfolios. The asset class was once too small to dent the appetite for gold. Now bitcoin and ether, the two biggest cryptocurrencies, have a combined market capitalisation of around $1.3trn, ten times what it was two years ago. That is around a tenth of the perhaps $12trn of gold holdings, based on the World Gold Council’s estimate that a little over 200,000 tonnes of the yellow metal exists above ground.
In 2020 Chris Wood of Jefferies, an investment bank, and a long-time advocate of gold, signalled which way the wind was blowing. He cut his rather sizeable recommended allocation to physical bullion for dollar-based pension funds from 50% to 45% and redirected the five percentage points to bitcoin. In November last year he did the same again, raising the bitcoin allocation to 10%, at the expense of gold.
Bitcoin’s wild price swings may for now limit the interest of the more conservative gold bug. Over the past five years the gold price has moved—both up and down—by an average of 0.6% a day, compared with a daily move in bitcoin of 3.5%. But that need not be a show-stopper in the long run. As analysts at Morgan Stanley have noted, gold also began its life as a modern investment asset in the mid-1970s and early 1980s with bouts of extreme volatility. It took almost two decades after the ownership of gold was legalised in America in 1974 for it to become widely held by institutions.
A spell of comparative irrelevance for the metal, then, cannot be ruled out. Stuck between more reliable, safe assets on one side and more exciting, speculative crypto-assets on the other, gold now finds itself in an awkward position.
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This article appeared in the Finance & economics section of the print edition under the headline “Lost lustre”
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