Everyone loves gold. It's sound money you see. Well, it used to be.

Hard to think of any other asset that has as many distorted and emotional connections to it as gold...

"It's an inflation hedge"

How'd that inflation hedge work out last year with inflation at 7%? πŸ‘‡


Maybe we could ask Bridgewater's Ray Dalio?

"Over the long run, the price of gold approximates the total amount of money in circulation divided by the size of the gold stock. If the market price of gold moves a long way from this level, it may indicate a buying or selling opportunity."

This was back in 2011 to be fair to him, but it's hardly a useful framework.

  • How do you define the long run?
  • When should you buy and sell?
  • What's a 'long way' from the correct price of gold in money supply?
  • Do bank reserves count as 'in circulation'?

We could be here a while...

So... What DOES matter for the gold price?

The willingness to hold the stock of gold depends on the rate of return available on alternative assets

What he said πŸ‘†

This is not a new idea. It was highlighted in the 1985 paper: Gibson's Paradox & The Gold Standard (so it's over 35 years old).

This is why Gold is a Doomer Asset

It's mainly in demand when everything's going badly. Time for a chart:

Gold overlaid with the 10 year real (after inflation) yield provided by the US treasury.

To make it easier to understand, the real yield axis is inverted. As the real yield heads further into negative territory, gold's appeal (and price) will generally increase.

Unless there are alternatives to gold that offer a favourable rate of return...

Even as real yields remained deeply negative over the past year, there were plenty of alternative options to earn returns in excess of inflation. The most obvious example is the S&P which returned 25% in 2021.

The potential for high equity returns meant there was no love for gold. Between August 2020 and April 2021 gold fell almost 20%...

The 2022 outlook isn't so clear for equity markets, so perhaps it could be a better year for our shiny pet rock.

Much will depend on the regime we are in.

There are those who say that the economy will continue to expand. Growth will come at a slower rate than the previous year, but still faster than the pre-Covid trend.

Others believe that the economy will slow. The Federal Reserve will hike into this slowdown and put an early end to the expansion.

There's a LOT of space between those two regimes too.

If the going's good, it's hard to see gold making much ground, other than occasional rallies in times of dollar weakness.

If things start to slow, gold could rediscover its appeal as money piles into bonds, driving yields lower.

After all, a zero-yielding asset is more appealing than a negative yielding bond.

When looking at gold, think of it as a portfolio allocator would, when asking themselves the question...

"Should I buy gold?"

If there are clearly better returns to be made elsewhere, the answer is probably "No".

At times of uncertainty and slowing growth, when prospects for outsized gains in equities and other asset classes are bleak, nominal bond yields will typically fall, many into negative territory.

Maybe then, your average portfolio allocator will turn into this guy... πŸ‘‡

And gold can sustain a rally.

Summing up...

  • Gold is a doomer asset.
  • When economic growth slows everyone piles into bonds, pushing global yields lower.
  • Massive pile of negative yielding bonds and lack of economic growth means limited opportunities elsewhere to earn yield = buy zero yield gold as a least bad option.

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