In today’s Finshots, we explain what’s driving gold prices higher and higher.

The Story

…gold is a lot like religion. No one can prove that God exists…or that God doesn’t exist. The believer can’t convince the atheist, and the atheist can’t convince the believer. It’s incredibly simple: either you believe in God or you don’t. Well, that’s exactly the way I think it is with gold. Either you’re a believer or you’re not.

We’re not saying that. That’s legendary investor Howard Marks’ take on the most polarising asset class in the world.

The reason why there are extreme opinions about gold is that, as an asset, it doesn’t generate any cash flow. Unlike a company which sells stuff and earns revenue, gold doesn’t have that feature. Or consider a bond. If you buy a bond issued by a company, you can at least earn an interest. You can’t say the same thing about gold.

Simply put, gold doesn’t have any intrinsic value. That’s why a lot of investors don’t touch it with a barge pole.

The only real value is because of sentiment.

The ‘gold bugs’ who buy it impute some magical powers to it. They say that central banks are playing fast and loose with paper money, so you need a physical asset for protection. There’s the argument that when there’s turmoil in the world, gold is a saviour that people rush towards. And also, gold is finite. It doesn’t have an endless supply. So you could accord some value to its scarcity.

And right now, the ‘believers’ are winning. Gold prices have hit all-time highs. In India, it has breached ₹66,000 for 10 grams.

So, we have to wonder why gold is on a massive bull rally right now. And we have to try and break it down a bit.

Is it global instability or a geopolitical crisis?

Well, there is definitely plenty of conflict in the world. The invasion of Ukraine doesn’t seem to have an ending, and this has hurt food supplies. Israel is still engaged in a war against Hamas in Palestine which affected shipments through the Red Sea. And there’s a worry of an armed conflict between two of the world’s big powers — India and China.

So yeah, you can see why gold would be attractive in such a situation.

But there could be a deeper issue at play here.

Remember how the Western world imposed all kinds of sanctions on Russia after it invaded Ukraine?

And one thing they did was also freeze Russia’s foreign reserves. The country had parked money in bonds and other assets in the West. And then found that it couldn’t access any of it due to the whims of the West.

Suddenly, other countries woke up to the fact that this could happen to them too if they ended up on the wrong side of the Western countries. And maybe that triggered them. But many emerging market central banks suddenly rushed to stock up on gold to park their currencies — they bought over 1,000 tonnes of gold in both 2022 and 2023. And you can be sure that trend is continuing even today.

Okay, what about inflation?

Typically, people say that gold is a hedge against inflation. But today, it’s cooling inflation that could be making the case for gold.

Confused?

See, the thing with gold is that it doesn’t offer any yield. There’s no interest paid out. So when a central bank like the US Fed keeps interest rates high, people prefer to buy things like a US government bond. It’s a more attractive proposition.

And since the US was battling high inflation ever since the pandemic, the US Fed also kept interest rates higher than it had been in the past decade.

So people rushed to buy bonds and gold took a backseat. And that inflationary hedge argument kind of broke down a bit.

But imagine this in reverse now. Imagine the US Fed starts cutting interest rates.

Gold wouldn’t suddenly seem so bad, would it? Investors won’t lose out on much ‘yield’. And it makes sense, especially considering the geopolitical mayhem in the world.

And that’s what is on the cards for gold today. The US economy isn’t battling high inflation anymore and the economy isn’t growing at a scorching pace either. There are worries about a slowdown leading to a recession. And since Jerome Powell, the man in charge of the US Fed, has pretty much said they’re “not far from” cutting interest rates, you can see that there’s some anticipation building up around gold.

Because as per a Morgan Stanley report, gold is quite sensitive to changes in interest rates. Over the past 25 years, the price of gold has jumped by 10% for every 1% fall in the inflation-adjusted interest rates of the US 10-year government bond.

So yeah, you can see why investors seem quite excited to buy the metal today.

Will it work out the way the gold bugs are hoping for? Or will inflation rear up again and spook the US Fed and gold as a result?

We’ll have to wait and see.

Until then…

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