Someone asked me over Raya if I was surprised that gold hasn’t performed as well as it should have done this year given all that is happening around the world – the tragic war in Ukraine; inflation in most markets; logjam in commodities.
I wondered whether it was more greed than anything else that prompted that question. If you look at the performance of gold against Malaysia’s KLCI, the S&P500 and the exciting bitcoin, gold has done what it was expected to do. While the KLCI is pretty much flat, the other two – S&P500 and bitcoin – are down in the year to May 2022. In contrast, gold is significantly up.
Has anything really changed since the start of the year? Thankfully it looks like the worst of the pandemic is behind us and we are emerging into a new endemic normal.
However, the war still rages on in Ukraine, there is still significant tension between the US and China. And perhaps most important of all when it comes to the investment sentiment, central banks around the world continue to fight against inflation.
The looming question is now whether they – and especially the US – can beat inflation without damaging economic growth. The possible outcomes are set out in the table below.
Up until the pandemic, the world has enjoyed an economically benign environment where economic growth was robust and inflation remained at historical lows – a period of deflationary expansion with associated low-interest rates.
When central banks fight inflation, they typically use interest rate hikes as their weapon of choice. The direct consequence of interest rate hikes for many of us is that our borrowings will become more expensive to service.
For as long as the economy continues to grow during this battle with inflation, we will have to deal with both higher prices for the goods and services we buy and use, and higher costs of borrowing for loans like our mortgages, our cars and our credit cards.
If, however, economic growth suffers in the fight against inflation, then there is a risk of stagflation. This is a scary outcome not only because stagflations can lead to rising unemployment and falling real income as wages struggle to keep up with rising prices but also because they are difficult for policymakers.
Central banks can increase interest rates to reduce inflation or cut interest rates to reduce unemployment. But, they can’t usually tackle both inflation and unemployment at the same time.
To a lesser degree, if inflation can finally be controlled but the economy falls into recession, then gold will likely continue to do well. But if the central banks can successfully bring inflation under control without damaging the economy, then we will revert to a pre-pandemic environment and gold prices will likely fall in line with inflation.
So why should you hold gold? Well, in 3 of the 4 possible outcomes above, I think gold will be a positive addition to your investment portfolio. Why? Because, as I have said in previous posts, gold typically grows in line with inflation so your savings will maintain its value.
Gold can be the insurance policy for your investment portfolio. This year’s performance is a good example of the role that gold can play as part of your savings.