It’s now over a year since the UK entered its first lockdown back in late March 2020, and it has been a rollercoaster ride for the markets. First, equities crashed and people withdrew from the risk-on trade, opting for safe havens and hedges, such as bonds and precious metals including gold.
In the past year, equities have staged an impressive comeback, but while this was getting underway, gold was already outperforming it. Now, as we start expecting a change in economic fortunes, inflation expectations are rising, and if history is any guide, gold looks set to outperform even further.
The ultimate inflation hedge
UK Bullion has been watching developments in the gold markets with great interest, especially given the fact that all signs point to higher inflation in the coming years. At the height of the COVID-19 crisis last year, many assets including equities, oil, copper and other commodities slumped in value, suggesting deflation ruled the roost.
However, money is beginning to flow out of the bond market at an increasing pace. As bond yields enjoy an inverse relationship to bond prices, outflows from British gilts means yields are spiking across the yield curve. That’s because markets are expecting the economy to perform strongly in the coming months, an inflationary trade which could lead to a rise in prices, unless policy makers take active steps to curb it.
Gold has traditionally been one of the greatest beneficiaries of inflationary economic environments. Remember the stagflation of the 1970s, as double-digit price rises were coupled with an exponential rise in gold prices. This experience was repeated again during the great commodity supercycle of the 2000s, as gold rapidly appreciated in value, as the price of raw materials soared during the Chinese economic boom.
In the 2020s, COVID-19 has done much to disrupt economic growth, but a sudden burst of activity as the pandemic lessens its grip on the global economy could have a dramatic impact on prices, creating a new inflationary episode which could catch central banks and governments off-guard.
As recently as 2015, an ounce of gold was worth £700, but by the summer of 2020, it was worth over £1,500 per ounce. Most of those price gains took place in just the last 12 months before last summer’s price peak. Imagine how much higher the price could go, if inflation causes gold to surge again this summer.
Ideal conditions for inflation
When it comes to inflation spotting, all the signs are there. While the UK economy remains significantly smaller than it was when it peaked in late 2019, the conditions are there to support a rise in inflation, and policy makers show little signs of tackling the issue. In fact, they are actively encouraging a return of inflation, and look set to allow price rises to surpass the two per cent target, before even considering a rise in interest rates.
Not only could interest rates remain low, despite soaring inflation,. The Bank of England (BoE) is also keeping a policy of bond buying in place, in the form of quantitative easing. Billions of pounds have been created out of thin air to buy up government bonds, and it is quite possible that this money could eventually trickle down into the real economy.
As any economist will tell you, the greater the supply, the lower the unit value. More pounds will start flowing around the UK economy, and policy makers are seemingly intentionally reluctant to tighten policy for fear of derailing the recovery. This reluctance to stop an inflationary surge could be the catalyst for further rises in the price of gold.
As inflation returns with a vengeance, low interest rates will mean real interest rates sliding into negative territory. Savings will be devalued, unless spent in the here and now, meaning wealth tied up in the banking sector could be lost unless invested wisely. Gold could offer that security – it has been a store of wealth for centuries.
Gold could withstand the inflation shock
While economists expect prices to spike in 2021 due to a base effect (what went down last year must surely bounce back up), the sheer amount of stimulus in the UK and abroad is enough to suggest higher inflation will come back to stay, even long after the post-COVID-19 price spike has passed.
The bond markets are a useful indicator of investors expecting higher prices down the road. The government issues debt with a range of maturities, with most of us expecting yields to rise if the maturity is further away, as a way of mitigating risk of future inflation.
A UK government bond which matures in 30 years has a yield of 1.3 per cent, compared to a yield of 0.4 per cent at the height of the COVID-19 shock in March 2020. Such a sell-off in bonds is an instinctive reaction by the markets, as investors expect higher yields to offset the inflation expected in the next three decades.
However, quantitative easing by the BoE is putting pressure on the short end – the part of the UK yield curve at which debt matures much sooner, within as little as a month in some cases. Yields on short-term debt are barely above zero, having recorded negative yields for much of the last year. This comes, even despite the sell-off on the long end, going to show just how many bond purchases central bankers are willing to make, to keep markets from fearing a sudden rise in interest rates anytime soon.
This is a fragile state of affairs, and if policy makers have made a fundamental mistake about the strength of a post-COVID-19 bounce-back, short term interest rates may spike anyway. Equities would perceive higher volatility, prompting a flow of money into safe havens such as gold, exactly as we saw in the 1970s. Gold is an attractive asset during times of economic instability, as it doesn’t provide a yield and gains can be made purely by price action alone.
The 1970s era of stagflation saw gold prices jump from £14.5 per ounce in early 1970 to a peak of £371 per ounce by early 1980. This rapid appreciation in prices over just a single decade transformed the public’s perception of gold from something seemingly out of reach into a useful and lucrative investment. Now, as we recover from the COVID-19 pandemic, prices could enjoy a parabolic rise, as policy makers seem asleep at the wheel.
If you’re interested in buying gold, get in touch with UK Bullion today. We have been facilitating sales of this precious metal for many years, and are happy to help offer a tangible solution to preserving wealth during times of economic turbulence. Give us a call on 0800 090 3256 to get in touch with a member of our team, and we will be happy to help with any enquiry you may have.