by Craig Erlam
As commodities go, few are as unique and versatile as gold. From its historical roots as the asset at the heart of monetary systems, to its enduring appeal as a status symbol to be adorned, the precious metal has shown lasting appeal.
Gold trading is highly liquid, and the international gold market can offer opportunities for traders.
But there are some common and long-held assumptions about gold as an investment asset that require deeper interrogation. In this article, I unpack three key factors to understand before trading gold.
Gold as an inflation hedge
One of the most commonly-held assumptions about gold is that it can offer protection against inflation.
During periods of high inflation, gold – a physical asset with intrinsic value and limited supply – tends to retain its value compared to fiat currencies, which decrease in actual value as the cost of goods and services rise.
While it is true that gold has historically demonstrated an ability to hold value and therefore to preserve wealth during periods of high inflation, this concept is neither foolproof nor true in all circumstances.
Gold may be more likely to act as a successful hedge against inflation in extreme conditions: for example, in a country experiencing runaway inflation or seeing its currency collapse. However, traders and investors should be aware that gold is not a guaranteed hedge against inflation, and that multiple factors influence the price of gold.
Gold as a safe haven asset
Many investors will be familiar with the concept that gold is a ‘safe haven’ in uncertain times, from economic instability to geopolitical turbulence. Seen as less correlated to asset classes such as stocks and bonds, gold’s relative stability means it is often viewed as a good asset to diversify portfolios.
While gold’s status as a stable asset even in an unstable market has built up over the centuries, it’s important to understand that gold is not immune to volatility. The safe haven maxim can be true, but it is still situation-dependent. In reality, a range of factors from market conditions to investor sentiment have an impact on the price of gold, and crucially, interest rates play a key role.
The impact of US interest rates
Unlike stocks and bonds, gold does not provide dividends or cash flow to investors. As a result, the price of gold is typically inversely correlated with real interest rates – specifically those of the US’s Federal Reserve, as gold is priced in USD. Broadly speaking, when US yields are high, assets that generate no cash flow become less appealing, and vice versa.
As a result, expectations around interest rates play into the price of gold too – and this is a difficult relationship to navigate. While actual changes to US interest rates only occur every six weeks following Federal Reserve meetings, expectations and sentiment around interest rates can fluctuate constantly.
Interest rate expectations can impact the price of gold in a number of ways: for example, higher interest rates in the US can lead to the USD appreciating, which makes buying gold more expensive for non-USD holders. Additionally, rising rates can be perceived as anti-inflationary, which can impact gold’s appeal to investors.
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