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The precious metal is struggling to hit new highs despite clear drivers for its price
Thursday 17 Jun 2021 Author: Russ Mould

Gold bugs get a kick out of telling investors with a heavy weighting toward equities that the precious metal has a better performance record than the S&P 500 index of US shares since the turn of the millennium.

The commodity is up by 547% over that period, while the S&P 500 has offered a capital gain of 192% and a total return of 337% (which includes dividends), in dollar terms.

Yet gold buyers may be frustrated by the metal’s inability to break above $1,900 an ounce, especially as inflation is starting to run hot in China, the UK and US.

For many, an increase in the cost of living and the implicit devaluation of the purchasing power of paper money forms the investment case for gold.

The metal’s inability to progress to new highs is reminiscent of its struggles to crack $1,300 between 2013 and 2019. It fits with the view of central banks that the current spike in inflation is merely ‘transitory’ and the result of pent-up demand, as economies slowly unlock, and supply-chain bottlenecks.

Fans of gold will point to its price chart, which shows the metal’s rapid ascent in the wake of a successful assault on $1,300 per ounce in May 2019.

It then shot up by nearly 60% to a peak of $2,053 in just 15 months. Sceptics will counter by pointing to gold’s long slump from 1980 to 2000 as inflation ebbed and argue that the metal will regain its status as a ‘barbarous relic’ if increases in producer and consumer price indices do indeed prove temporary.

Debt bonanza

The past is no guarantee for the future but an analysis of gold’s performance relative to inflation since 1970 helps to explain why precious metal fans think that rising prices may bring gold back into the mainstream when it comes to portfolio allocation strategies.

Government budget deficits, record-low interest rates, quantitative easing and rampant money supply growth are also persuading some investors to abandon ‘paper’ money and ‘fiat’ currencies in favour of ‘real’ assets.

The inflation debate is likely to rage for some time but even the fiercest critic of gold may accept that politicians are still inclined to spend, either to fund what they view as vital, planet-saving projects, support the economy during the pandemic or simply curry favour and buy votes. Austerity is a vote-loser.

The issue of taxation and who should pay more and by how much is gathering pace, but whether it is enough to fund ambitious spending programmes in the US, for example, remains open to question, even if the Republicans seem unwilling to embrace all of President Biden’s projects.

A British Prime Minister whose own personal financial arrangements seem unorthodox at best is unlikely to be a good choice as someone willing to apply rigorous checks and balances toward the use of other peoples’ (taxpayers’) money either.

All in the timing

One reason behind gold’s outperformance of the S&P 500 since 2000 is the metal was trading at its lowest levels since 1979 at the turn of the millennium, following a two-decade bear market for the metal, while the US equity market stood near record highs after a near 20-year bull market for stocks.

As with any investment, the price paid is the ultimate arbiter of investment return. The trickier bit now is that gold is trading near a record peak, in absolute terms, even if the S&P is there already.

But history suggests government spending and rising deficits are good for gold because investors look for stores of value to preserve their wealth. Gold is hard to find and costly to mine, so supply grows slowly, in contrast to the supply of money.

Investor Warren Buffett is not known to be a fan of gold but in 1980 he wrote: ‘The rub has been that government has been exceptionally able in printing money and creating promises, but it is unable to print gold or oil.’

An unexpected tightening of monetary policy, or a new round of tax rises and austerity measures, could easily stop gold in its tracks as well as being negative for stocks. The question is whether central bankers and politicians are able and willing to go down those paths.

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