ResearchThe Weekly (4/5)

The Weekly (4/5)

Apr 5, 2024

Barely a day goes by without excitement over the artificial intelligence gold rush sending another company’s market value through the roof. The same gold rush fever can be applied to ‘digital gold’s’ meteoric rise over the last year (h/t BTC).

If we were to tell you that amidst a run of risk on assets like AI and crypto, that the one of the most traditional ‘safe haven’ or hedging assets was racing higher, that might surprise you.

Although not as fancy, there’s another gold rush happening that isn’t making headlines like the others. A gold rush in the most traditional form: physical gold reaching new all-time highs.

Most well known for functioning as a strong inflation hedge, the recent rally in gold is a bit perplexing given its price action when inflation was peaking in 2021.

Say you knew, at the start of 2021, that inflation was going to soar, there is perhaps one asset above all others that you would have dumped your life savings into: the precious metal that adorns the necks and wrists of the wealthy. Ironically, though, in a time when inflation was at its highest levels in recent memory, the price of gold rose a mere 3% from the start of 2021 to the middle of 2023.

What’s interesting is that as inflation has started to track back towards the Federal Reserve’s target of 2%, the price of physical gold has counterintuitively outperformed the S&P 500 to start the year. Gold is now solidly outperforming stocks and is back to all-time highs.

So what exactly is going on?

Working out the right price for gold is a difficult task. Enthusiasts point to the metal’s historical role as the asset backing money, its use in fine jewelry, its finite supply and its physical durability as reasons to explain why it holds value. After all, at first glance the phenomenon is a strange one: in contrast to stocks and bonds, gold generates no cash flows or dividends.

Because gold generates no cash flows, its price tends to be inversely correlated with real interest rates—when safe, real yields, like those generated by Treasury bonds, are high, assets that generate no cash flows become less appealing.

So to break it down: gold is considered a solid inflation hedge but inflation is decreasing. Real interest rates are at their highest levels in over a decade which should mean gold is out of favor. Then what is moving prices higher?

Given that the market’s take on the direction of short-term rates (from ~4.25% to ~4.65%) has actually moved higher to start the year, it’s difficult to attribute the surge in prices to future rate cuts.

It could be argued that investors aren’t certain the inflationary environment from 2021 is behind us and are piling in ahead of a surprise move higher. This could be true, but the data suggests that this is unlikely.

So it leaves us with that idea that traders are attempting to front run central bank purchases later on this year.

Rising geopolitical tensions and political uncertainties make central bank gold reserves more valuable to many countries than just a few months ago. Gold, much like Treasuries which function as another central bank stalwart, is priced in dollars, highly liquid, and respected as a store of value. The difference? Physical gold isn’t subject to sanctions like Treasuries might be.

The rally has been impressive but it casts a potentially ominous shadow on other assets. It suggests that other foreign governments may feel the need to hedge against geopolitical outcomes which could signal negative catalysts for other risk assets, like stocks.

Investing is largely a mosaic. The surge in the price of gold isn’t enough reason to sound the alarm bells just yet, rather it’s one piece of a broader puzzle that has piqued our interest.

A new gold rush has begun and it’s one of the tales as old as time.

Have a great weekend,

– Your Titan team

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