What asset class does everyone love to hate and has just hit an all-time high in unusual circumstances?
Yes, I am talking about gold, which broke through the $2,500/ounce mark for the first time ever in August. In one sense, this price level is not important at all – it is just a nominal number. Like most other price series, such as share prices, earnings, wages, and inflation, it tends to rise over time.
Real (inflation-adjusted) prices are usually the party-pooper for new stories about fresh all-time highs, and that is true of gold as well. When adjusted for inflation, the latest reading just about beats the Covid-surge that hit $1,976/ounce in July 2020, but is still behind the 2011 and 1980 peaks, at least at the time of writing.
Simply talking about price movements alone is not a very satisfying analysis, and here is where gold sceptics understandably get frustrated – there is vanishingly little fundamental basis for valuing gold. As an asset class, there is no underlying business or activity where you can assess the cash flow to estimate a fair valuation.
For those that look to it as a pseudo-currency, there is no sovereign nation behind it, so you cannot assess it based on fiscal or monetary policy conditions. Some investors try comparing the price relative to other commodities such as oil, but this is not a particularly reliable ratio, and oil has its own peculiarities.
Other investors try to gauge supply and demand dynamics, but there is relatively little insight to be added here. Supply is, by its nature, constrained, and at best, you can infer a rough ‘floor’ based on the marginal cost of production, which is probably around the $1,250 level.
However, there is no rule or hard mechanism that intervenes below this level, and since it is used primarily as a store of wealth, there is no reliable way to determine what a ceiling should be.
In the absence of fundamentals intrinsic to the asset class, we are forced to look at extrinsic factors – who is buying gold and why?
It has been surprising to see the yellow metal continue to rocket, as rising real interest rates are typically bad news for gold, which has a yield of precisely zero.
Why hold gold, which does nothing, when you can hold a minimal-risk government bond to maturity and comfortably get a 4 per cent yield a year also for doing nothing?
The main answer is that it is considered by many to be a useful store of wealth, especially when central banks around the world have been engaging in large-scale monetary policy experiments over the past decade.
Examples of such experiments include quantitative easing, quantitative tightening, yield curve control, zero or negative interest rate policies and the risks of competitive currency debasement – especially in the face of potential renewed US/China trade tensions.
