Your Money: A higher inflationary environment is good for gold

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June 07, 2021 4:15 AM

Just how much gold prices will rise will depend on how sustainable is the economic recovery

Maybe that's why, after chasing higher returns and enduring big swings over the last few months, funds seem to be now reversing from cryptocurrencies like Bitcoin to gold as investors appreciate the reliability and stability of the precious metal.Maybe that's why, after chasing higher returns and enduring big swings over the last few months, funds seem to be now reversing from cryptocurrencies like Bitcoin to gold as investors appreciate the reliability and stability of the precious metal.

In May, gold prices rose above the key psychological level of $1,900 per ounce, ending the month roughly 8% higher and turning positive for the year to date. Much of May’s action in gold was a result of evidence showing a rise in prices in the United States and the weakening of its key rivals—the 10-year Treasury yield, the Dollar Index and Bitcoin.

Rising inflation in the US
With trillions of dollars of stimulus trickling down to the real economy, accelerating vaccination rollouts and unfixed supply chains, higher inflation has become the central market-moving theme so far in 2021. In the US, Personal Consumption Expenditure jumped 3.6% in the year to April. The Consumer Price Index registered a 4.2% growth in April, its largest increase in almost 13 years. A higher inflationary environment is good for gold, which is seen as a reliable store of value especially when rates are anchored at zero levels in much of the developed world.

Confidence about the economic outlook thus seems to be fading now nudging investors to increase their allocation to gold. Risk assets riding on easy money, however, continue to do well, raising concerns of frothiness and limiting a rally in gold prices for now. But going forward, markets might get a reality check as the timing of recovery gets pushed further down the road and the disconnect between the economy and financial markets becomes evident. Gold will then yet again prove to be a relevant portfolio asset.

Volatility in crypto
The sheer price performance of cryptocurrencies or the fear of missing out lured many investors to chase this well-marketed promise of an alternative form of digital currency and helped push Bitcoin to a record near $65,000. But this journey upward has been one of extreme volatility given that it is a relatively new asset class with fewer participants and a debatable intrinsic value, which makes it susceptible to large price fluctuations and speculation. Most recently, the cryptocurrency saw a massive 37% correction in May. Maybe that’s why, after chasing higher returns and enduring big swings over the last few months, funds seem to be now reversing from cryptocurrencies like Bitcoin to gold as investors appreciate the reliability and stability of the precious metal.

What lies ahead
After a healthy correction due to rising confidence about the economic outlook, gold’s return to $1,900 levels seems logical and overdue as prices were stretched to the downside given the fundamentals. Just how much gold prices will rise and how strong its move will depend on how sustainable the economic recovery is, and the resulting policy action which can either be status quo or tightening. Also, at any first signs of dwindling economic momentum, central banks can be expected to intervene with higher deficit spending. On the other hand, it will also depend on whether or not this higher inflation is transitory and in reaction, whether or not the US dollar and real yields trend down further.

Gold is also expected to reflect investor concerns over record debt and deficit levels, frothy financial markets and the emergence of inflation, thus strengthening going forward.

The writer is senior fund manager, Alternative Investments, Quantum AMC

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