Gold is neither a risk nor safe haven asset. Rather it is a currency hedge that rises or falls with concern about the continued purchasing power of fiat currencies, specifically the most widely held ones, the USD and EUR. That concern can vary regardless of whether we’re in a time of global expansion or contraction.
A. Gold Can Rise Or Fall In Times Of Expansion
Gold can rise due to fears of inflation from too much money chasing too few goods.
Gold can fall if investor’s believe returns from risk assets will outpace inflation, and investors abandon gold (which has no steady yield) in search of higher returns. In other words, loss of purchasing power isn’t a concern because risk assets appear to offer inflation beating returns.
B. Gold Can Rise Or Fall In Times Of Contraction
Gold can rise if the US or EU engages in stimulus actions that are perceived as money printing and thus potentially inflationary, and both private and sovereign investors (like central banks) seek better stores of value than the USD or EUR. This has been the primary driver of higher gold prices in recent years.
Gold can fall if the contraction brings very low inflation, deflation, or rising demand for cash as struggling investors need liquidity to cover margin calls from falling asset prices or to cover declines in income. This is the likely driver of the current downtrend in gold that began in September 2011, and would be the primary driver of a continued move lower if we see a sustained significant deterioration or economic collapse in the EU and/or China, Japan, or the US.
Given the above, it’s amusing to hear the mass media alternate between referring to gold as a risk or safe haven asset, usually depending on nothing more than how it has behaved in recent days or weeks. For example:
- Throughout most of the Great Financial Crisis that began in earnest in late 2007, the press would view gold’s accelerating rise while stocks and other risk assets fell, and refer to gold as a safe haven asset. In fact gold was rising due to US stimulus policies that were believed to be inflationary.
- During times of exceptional fear, like the downtrend in risk assets that began in September 2011, most writers simply saw that gold fell along with other risk assets like stocks, and so labeled gold a risk asset. In actuality, gold was falling due to a combination the need for liquidity as other asset prices fell, and no immediate signs inflation threats.
In both of the above cases, the press correctly saw a correlation between gold and risk assets but badly misread its cause.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.