Since August last year, despite widespread mistrust in the investment community about the effectiveness of gold as a hedge against inflation, gold's returns have reached double digits, while global stock markets and bonds have fallen almost entirely. Although according to the current real interest rate situation, the trend of gold may decline in the short term, but the long-term bull market of gold still exists. In addition, gold has a good ability to hedge geopolitical risk, which adds additional benefits to the broader portfolio.
Gold has once again proved its value as a hedge against inflation
Commodity prices soared in the wake of the escalation of the conflict between Russia and Ukraine, once again highlighting the usefulness of gold as a hedge against inflation. Although gold underperformed the composite commodity index in large part because of soaring oil prices, the rebound in gold prices once again demonstrated its superiority over legal tender. The chart below shows that when denominated in gold, the recent commodity rally is only a small rebound in the long-term downward trend. If denominated in dollars, commodity prices are as high as they were in the 1980s, even after taking into account cash interest.
Real bond yields suggest that gold will weaken in the short term, but it is unlikely to last.
The price of gold is likely to fall in the short term. As the chart below shows, based on real bond yields, the recent rise in gold prices seems to have exceeded its short-term fair value.
However, real bond yields will continue to fall as the gap between inflation expectations and interest rate expectations continues to widen amid growing global resource constraints and a continued surge in the supply of money and government bonds. Although US money supply growth has slowed from its peak, it is still growing at a double-digit rate, higher than the previous peak.
Long gold allows investors to take a more aggressive stock position.
The use of gold lies in its ability to perform well in the worst possible economic times, when it is most needed. The conflict between Russia and Ukraine highlights the importance of owning gold in the portfolio. In a portfolio, although equity positions have suffered losses, heavy positions in precious metals can make up for this loss and achieve strong overall returns. This gives investors the confidence to increase their positions in European and emerging market stocks.
The fall in the price of gold from now on is welcome because it almost certainly reflects an improved global economic outlook and a reduction in the risk of nuclear war. If so, the outlook for equity returns for investors will improve and the risk of inflation will fall.
