Gold Is No Longer a Good Hedge Against Bad Times

Those who remember or read about the 1980s may consider the price of gold to be a highly dramatic variable. During the postwar Bretton Woods years, the price of gold was pegged at $35 an ounce, but after Richard Nixon severed the dollar’s final link to gold in 1971, prices soared to more than $800 an ounce by 1980. Fortunes were made, gold bugs proliferated and the price of the precious metal became a daily fascination. Many commentators considered the high price of gold to be a harbinger of disaster for both fiat currency and Western civilization.

Even if it’s trading around a record high of $2,000 these days, gold is a little boring and likely to remain so for the foreseeable future. According to a new study from the National Bureau of Economic Research, gold prices have followed some fairly standard principles since at least 1990. To put it simply, gold prices decline when real interest rates rise. That is because gold itself has zero direct yield, so at higher interest rates the opportunity cost of holding gold goes up.1 In this regard, gold is like many other assets, including crypto, tech companies, and real estate.

A Boring Commodity | In a world of rising interest rates and slow economic growth, gold just doesn't hold much appeal

The price of gold also goes up (down) when demand for it as a commodity goes up (down). So, if say China becomes a major global economic power, the Chinese economy will need more gold, if only for its commodity uses, and that in turn will boost gold prices, as it did starting in 2002. There is also sizeable gold jewelry demand from India, so as that country becomes wealthier that too will boost the demand for gold and thus its price.

Under both mechanisms, gold is no longer a good hedge against bad times, as it correlates with both low-interest rates and global economic growth. Gold becomes another cyclical economic asset, and that is a big part of the reason why gold prices are no longer followed so closely or seen as useful harbingers of social and economic collapse. Instead, it is perfectly fine to have a high or rising price of gold.

The price of gold seemed so dramatic in the years surrounding 1980 because markets and prices had been suppressed for so long in the previous years. So, at that time it was very hard to know what gold truly was worth because various prices had not been tested much in the markets and by market procedures for trial and error and value discovery.