As of the evening of 28th January, gold has rallied to nearly $5,400 per oz, up almost 25% during January alone and double the price of last January.
These moves are of a significantly larger magnitude than we might expect, and we have seen many market participants rush to provide a rationale for this. All these probably have a grain of truth to them, and you can certainly build a plausible narrative that might justify the move.
For example, central banks do seem to have been increasing their exposure to gold as part of their foreign reserves, largely at the expense of US Treasuries (but this has been happening over the past few years rather than the past few months). It is probably also true that they are much less price sensitive than many other investors, given their scale and time horizons. Although it would be very surprising for central banks alone to have driven such a rapid, large price move.
In a similar vein, when developed economies are showing no ability (or even willingness) to balance budgets or control their government debt, it seems reasonable to fear that they might want to try to inflate away that debt – the finite supply of gold should mitigate that inflation risk. But in that case, why aren’t inflation-linked bonds rallying as well? They would mechanically benefit from higher inflation in the future – but they have remained range bound recently. So maybe this is part of the story, but it doesn’t feel like the whole story.
With regard to the theories that Indian or Chinese retail investors are buying all the physical gold they can get their hands on, we have no concrete way to verify this – gold is one of the investment assets that is less transparent than we would like, so it can be hard to keep track of where all the gold actually is at any time (which is precisely the point for some holders…).
As for the final theory, this is probably the one that I have the most confidence in. We are all told that “past performance is not a guide to future returns” whenever we read the small print for investment opportunities. The reality is though that it is not true – there is a host of academic research that demonstrates that things that increase in price are more likely to continue to increase (and vice versa). This is known as “momentum” or “a trend”. There are funds that seek to identify and profit from trends in financial assets, known as “trend following funds”. The larger these funds are, the more they can be self-fulfilling in that they not only follow a trend but can also exacerbate it. Evidence suggests that this has been happening over the past few months.
Gold is unique as an investment asset as there is no financial reason to own it. It’s not like an equity, where you own a share of a company and therefore a claim on its future profits. It’s not like a bond, where you lend money and expect repayment in the future along with interest. It’s not like an industrial or agricultural commodity, whose prices are largely a function of supply (making/mining it) and demand (as food, raw materials, etc.) – when you own it, it has value because you are confident that somebody will need to use it in the future, so will need to buy it from you.
Gold does not produce any cash flows for the holder (in fact it costs money to store it, so it effectively has a “negative dividend”), and its industrial and commercial use is tiny compared to its impact as a pure investment or store of value. So ultimately, gold is worth something primarily because we all collectively believe it is worth something. It is like a fiat currency, or, as Willem Buiter once said, “a 6000 year old Ponzi scheme”.
In my opinion, gold “works” as an investment because it is thought of as something safe to own in times of uncertainty – it is (theoretically) tangible in that you can hide it under your mattress when you don’t trust your banks, or your government or even that the cash in your wallet will be worth something tomorrow. Today’s economic and geopolitical environment is rife with uncertainty. As the post-Cold War structure is upended, central bank independence is challenged, and we are being told that AI is coming for all of our jobs – so is it any wonder that we want something “safe”?
Sacha is a portfolio manager of the Quilter Investors Cirilium and Creation Portfolios. Prior to joining Quilter Investors in 2011, Sacha worked at Broadstone with their team of economists before moving into asset allocation and fund manager research.
Sacha is a CFA charterholder and has also completed the Chartered Alternative Investment Analyst qualification. Sacha has a degree in Maths from the University of Bath.
