Gold – Will its Price Rise Further?

Gold prices are skyrocketing. The price of the yellow metal futures in the US has hit an all-time high at $2350. In India, the yellow metal trades at Rs 71,000 per 10 grams and is up 69 percent in rupee terms since the start of the Covid-19 pandemic in March 2020. In last 5 years, Nifty rose 93%, gold 78%, and S&P 500 80%. This rise is historically exceptionally high.

There are various reasons that can drive gold price like demand supply situations, geopolitical risks, global economic risks, and inflation.

To know the real reason, we need to know which of these factors is the strongest.

Demand supply factors are mostly known as gold has limited supply and jewelry demand (main consumption use of gold) does not fluctuate widely and its long-term trend is stable.

Current geopolitical risks are slowly rising but the chances of them spreading further are very low.

Global economies are mixed. Mostly expanding, few major economies are in recession (UK, Japan, Finland, Ireland).

That leaves inflation as the main culprit.

In old times, currencies were linked to gold price.

Today, this is no longer the case. Most governments have migrated to fiat currencies, where the value of the currency is based on factors such as monetary supply or trust in the government to repay the country’s loans. While this is risky for currency holders, it gives governments freedom to increase or decrease monetary supply based on their economic goals, and not based on how much gold they have.

This also means that when trust in the government or economy falls, the value of their currency also falls. In such cases, investors turn to gold, to prevent loss from currency depreciation.

When the dollar’s value increases against other currencies, it leads to a depreciation of gold prices. Because investors outside US looks at the price of the commodity in their local currency (which will be more expensive), so the demand for gold would decrease – and vice versa.

So, gold has an inverse relationship with the US dollar. As the strength of the US dollar rises, gold prices tend to fall.

This week’s CPI numbers were roughly the same as last month. While the core CPI figure, which excludes food and energy, remained flat, the year-over-year headline metric ticked up from 3.1% to 3.2%. This is not what you would expect if inflation was decreasing back to the Fed’s 2% goal.

CPI chart

It seems from the chart above that the Fed has won the inflation war. Inflation is down!

But it is treating the symptom. Paracetamol can bring down the fever, but has it cured the disease? Similarly, high interest rates have brough down the inflation, but has it cured the disease that is causing inflation – no. This disinflation is transitory, inflation will rise again.

Since 2020, we have repeatedly written about money printing by global central banks (mainly US) being the root cause of global inflation. Links – Inflation Super Cycle, How long can inflation continue? Where to invest now?, Housing Bubble 2

A hotter-than-expected Producer Price Index (PPI) report last week also contradicts Powell, with the PPI increasing from last month by more than twice the most conservative estimates.

US PPI

Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low.

A recently announced 13% federal deficit increase, does not bode well for the economy:

US Fed Deficit Chart

Rising fiscal deficit means rising government expenditure. Government is forced to pay for Medicare and social security. This is why the Fed is not only going to taper the QT [quantitative tightening] program but go back to quantitative easing because government spending is going ballistic. And all of it is stoking the fires for inflation.

Pandemic forced US government (and many others as well) to go for record‐​high deficits and financed it by printing money. It created an intense bout of inflation which has come down but will rise again as its root cause has not been treated.

Fiscal dominance has happened in various countries. Argentina is a textbook case of fiscal dominance. To finance fiscal deficits, the Argentine treasury issues bonds that are bought up by the central bank. This debt monetization has led to devastating inflation, reaching a 12‐​month rate of 276 percent in February 2024.

After World War I, Germany realized it could not pay off its debts through conventional taxes alone, so it rapidly printed money to finance new spending. Likewise, President Erdoğan of Turkey eroded central bank independence, pushed for lower interest rates, and expanded government spending in recent years. In both cases, fiscal dominance resulted in severe and economically damaging inflation.

Germany faced hyperinflation as it rocketed up to a monthly inflation rate of approximately 29,500 percent in October 1923. It took approximately 3.7 days for prices to double. Hyperinflation was scary and nothing like the inflation we are living in today. A loaf of bread would have cost 0.63 marks (German currency) in 1918, which increased to 201,000,000,000 marks in 1923, during the peak of hyperinflation.

In case of Turkey, inflation rate was 67% in February 2024.

Fiscal dominance is real, the US problem is not at its end, it has just started! Its impact will be global and devastating.

Coined Wall Street’s safe haven asset, gold is able to store its value in real terms amidst volatile economic weather and provide a hedge against rising costs of living, unlike cash. Central banks have their own gold reserves as a safeguard against financial turmoil.

According to the 2020 Central Bank Gold Reserves Survey, central banks have cited one of the top reasons they are holding on to their gold is because of the precious metal’s “performance during times of crisis”, and 20 per cent of them are looking to increase their gold reserves over the next 12 months. [Source: Standard Chartered Bank]

Inflation disease has not been cured, it is here to stay and rise. And so gold prices will see even higher levels in years to come.