Inflation expectations have been falling in many countries around the world this year. Gold is often viewed as hedge against rising inflation. Does the fact that people expect inflation to be lower from now on mean that gold can’t go any higher from here?
Not at all. Quite on the contrary.
Yes, gold is often used as an inflation hedge, so higher inflation can help boost its price. But gold is also held as a safe haven asset in times of stress and uncertainty, and no one can say that stress and uncertainty have been falling this year!
More to the point, gold is just one of a panoply of investment choices that people have when deciding where to park their money. It has one drawback for the average investor: unlike bonds, which pay a regular coupon, or stocks, which usually pay dividends, it doesn’t pay anything to the holder. So there’s an opportunity cost to holding gold – you lose the opportunity to make money that you could by investing in some other asset.
That’s where the fall in inflation expectations surprisingly becomes a plus for gold. As inflation expectations fall, central banks around the world are taking more and more aggressive actions to prevent inflation from falling. They’ve been cutting interest rates and buying bonds to increase the money supply. As a result, formerly high-yielding currencies such as the Australian and New Zealand dollars now have interest rates well below those of the US dollar.
Meanwhile, bond yields in Germany, Switzerland and Japan are negative across the curve, meaning that it costs you money to buy their bonds and hold them to maturity. Switzerland in fact now has the lowest interest rates in recorded history – minus 0.75% for three-month deposits. Even Greece, not so long ago the basket case