With inflation the top talking point of financial markets in 2023, the question on a lot of investors minds right now is: how do I invest in something which outperforms inflation?
Right now, finding something that is a safe bet to outperform inflation rates of up to circa 7% is not easy. Central banks only weapon with combatting inflation is raising interest rates. We all know that higher interest rates are typically bad for pretty much every investment one can think of.
Higher rates mean savings accounts become more attractive. Mortgage expenses rise, which pushes more excess cash into offset accounts. Housing markets suffer as borrowing capacity drops. The share market looks less attractive as dividend yields start dropping below savings accounts. Bond markets sell off to bring yields in line with higher rates. None of this is good for either speculation or investment.
But what about gold?
With the gold market yet to truly really react in positive fashion, many gold investors are wondering if gold can actually outperform inflation and keep them above water. So far in 2023 we’ve seen gold behaving quite sluggish. But when comparing gold performance to multiple currencies it paints a more positive picture.
If we take a look at the calendar year 2022 performance across multiple currencies, gold has performed quite well as an inflation hedge in pretty much everything except US dollars. Gold has outperformed cash in this period by a substantial amount in most currencies.
With inflation running rampant in a lot of countries we have seen a great deal of US dollar strength in the past year, impacting gold returns in the most quoted currency. Last year the US dollar was acting as the ultimate safe haven, likely upsetting many American gold investors, but if that choice of safe haven flips to gold you could expect to see a much more positive year ahead.
Gold is most certainly an effective inflation hedge for currencies experiencing hyperinflation. We can see the gold chart in Turkish Lira the past 2 years has risen 174% and would have protected local investors to the horrific inflation rate which currently sits at 57%.
Not even the central bank of Turkey itself has confidence in it’s own fiat currency, as they were the largest purchaser of gold in 2022, adding 103 tonnes to their balance sheet. They haven’t slowed down either, with another 23.3 tonnes purchased in January 2023, and close second on the list after China for the largest net purchases of gold in the past quarter. In a desperate attempt to give some confidence to their failing currency and to support the banking system, the central bank turns to the oldest and most trusted currency we know, gold.
Historically gold has maintained it’s position as one of the easiest and most important hedges against inflation over the long term, with prices often appreciating faster than official inflation rates. Despite the somewhat lackluster year of 2022 (especially in USD terms), there are a few reasons why we think gold could live up to its reputation much better in 2023.
What will get gold moving in 2023?
Looking forward, we see two main themes for gold this year. The first is strong Central Bank demand. The second is an economic crisis forcing central banks to reverse monetary policy direction and switch to an easing bias sooner than most expect. The so called “central bank pivot”.
We saw Central Bank demand hit new records last year and it makes perfect sense. With inflation levels soaring, gold is a great alternative for central banks to diversify their currency holdings/reserves. This demand from central banks helped keep a floor in the gold price last year. We don’t expect inflation numbers to drop off dramatically this year, so we expect this demand to continue moving forward.
The second major theme is that we see an unavoidable economic crisis brought to you by the very people trying to prevent one. The irony behind the moves of central banks in trying to combat inflation is that they will undoubtedly bring on a major credit crunch that will lead to an economic shock that could surpass the GFC.
Why? Global debt levels today are far worse than at the time of the global financial crisis. We haven’t solved any of the initial issues which caused the last crisis, we simply had central banks initiate the easiest monetary policy seen in history, with zero or negative cash rates and a whole lot of quantitative easing. This helped us build the biggest debt bubble the world has ever seen and now central banks will pop that bubble with higher interest rates.
Each of the last three recessions in the US, including the GFC, occurred shortly after a rate hike cycle and this latest one is both larger and swifter than the hiking cycle that popped the US housing bubble in 2008. If you are betting this one is going to be any different you had better be getting good odds.
Even though we haven’t hit crisis mode yet, we can already start to see the backlash towards central banks, with the RBA governor in the spot light recently, with many Australians struggling under the burden of higher costs of living combining with rising mortgage repayments.
With a recession on the way, there is going to be a great deal of political pressure put on Central Banks to stop their hiking cycle prematurely and let inflation do its thing, in a tradeoff for one evil over the other. When this happens, we would expect an explosive resurgence in gold demand from all angles. Retail and central bank demand would both likely be very strong if we get a pivot in policy before the inflation beast is tamed.
Recent price action certainly looks in favor for local investors. The $AUD is typically a risk-on currency, which is vulnerable to quick sell-offs in times of economic headwinds. It’s early days, but we won’t be surprised to see the gold price in AUD terms outpace the official CPI number this year and get back up into all time highs.
*Update – 22/03/2023*
Since we published this article on the 2nd of March a lot has happened since. We have seen the biggest banking collapse since the GFC with Silicone Valley Bank folding and Credit Suisse having to be bailed out by UBS, sending $17 billion worth of Credit Suisse bonds to $0, with bond holders losing everything.
The gold price in AUD terms is vastly outperforming inflation since the 1st of January 2023 to date (22/03/2023) – currently up 9.5% since the start of the year.
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