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Turmoil in the Safe Haven

It is height of the 1970s energy crisis. Everyone is panicking over the rising price of oil and soaring inflation. They can feel how each dollar can buy less. But you are sitting calmly in your chair, totally unaffected. Now and then you glance at a gold bar on a table next to you and you know… Everything will be fine.

That’s how it worked since the start of speculative investing. In times of uncertainty and market stress, investors turned their heads to the so-called safe heavens – certain minerals, treasury bills or safe currencies expected to retain or increase value during turbulent times. The most renowned was of course gold.

A jump back to the present – inflation hits record highs all over the world, S&P 500 is down 23% since the beginning of the year, there’s an all-out war in Ukraine and we head into recession. Seems like the yellow shimmering metal should be doing better than ever. Yet, it isn’t. Although gold peaked in March, amid the war panic, its price is now down 19%, putting it at a precipice of the bear market. And so emerges the question, what’s going on?

To fully understand that, let’s take a step back. Gold is like a “cool uncle” of crypto, the one that visits on Christmas, tells some cool stories and makes you want to be him when you grow up. The mineral is a scarce speculative instrument, that theoretically can be used as a currency, but not manipulated by a government with a working printing press. Add to that the loss of value in 2022 and it really does look like a “family”(hope you’re doing well, bitcoin traders). One major difference is the history, that crypto doesn’t have.

The shiny metal was widely used as a status of wealth and debuted in coin form around 560 B.C. The popularity was likely due to its durability (biting the coin really made sense). Over the years it gave wealth to countless, probably none more than shovel producers. However, gold’s value and use grew perhaps the most significantly in the late 18th century, when countries adopted a bimetallic standard, where every monetary unit had to be backed by gold or its less popular brother, silver. This lasted until 1971 when it was finally replaced by floating fiat currencies, guaranteed by the government and dependent on its stability rather than any physical resources.

After the standard was abolished, gold’s price skyrocketed and reached an all-time high of $2,586 (inflation-adjusted to today’s dollar) per ounce in 1980, a 2,300% increase. All that in the midst of rising inflation, energy crisis and war in the Middle-east. A familiar setting, yet different results. Then, there are more recent cases of the great recession and the COVID-19 crisis. Slow recovery from the 2008 crisis resulted in a four-year climb in gold value and the peak marked the highest price of the shimmering metal in the 21st century. The Corona-crisis, though much shorter lifted gold again, just shy of this peak. So, what’s wrong now?

A common misconception is that the gold price is directly connected to the level of inflation. The sentiment comes from the crisis of the 1980s and is only partly true. Though it played part in gold’s increase in value back then, the rate of it was likely accelerated by the end of the bimetallic standard and the poor decisions of the government – focused on re-elections and not economy impact. The latter resulted in tanking Dollar and bond prices. Although gold seems to protect purchasing power in the long term, it has little effect in the short run.

The opposite goes for the case of panic or the “emergency planning”. Some feel safer with an ounce or two in a pocket when crisis emerges, but, as seen in March, the need is mostly a only short-term one.

The current gold price is strongly affected by the Fed’s efforts to combat inflation. Four straight raises by 0.75 percentage points aim to cool down the red hot economy. The actions resulted in 14-year high-interest rates of 3.75%-4% plus palpitations and outrage in every finance bro in the country and beyond. The chairman, Jerome Powell, has also warned it will not be the last time the rates move up, as the hiring slowdown is still insufficient.

The higher interest rates impacted the government bonds, another instrument considered a safe haven and gold’s competition in this domain. Its increased return at a very low risk puts another setback to mineral’s position on the market and is unlikely to change soon with further raises of interest rates on the horizon. This stance is the major difference between now and the Covid times when the rates were at almost 0% level and bonds weren’t considered by investors.

A sharp eye and the application of 3rd-grade mathematics might reveal that the 14-year high, mentioned above, translates perfectly back to 2008. The Fed back then applied rates of above 5% and yet gold still increased in value. That’s due to two more factors that play into it.

Firstly, as Schroders reported, there is a negative correlation between shiny’s price and the real interest rate in the U.S. Its calculation is achieved by subtracting inflation from the interest rates (yet again complex math involved). Although the real interest rate is now much lower, due to significant inflation, the Fed’s actions caused its increase and lessened the profitability of gold in eyes of investors. 2008 saw the exact opposite with the rates being lowered and inflation on the rise.

Secondly, Fed’s actions and an economic slowdown in Europe and Asia increased the value of the U.S. dollar. As is the case with the majority of commodity markets, gold is priced globally in the greenback. With the dollar at a two-decade high, both stocks and commodities have been on the decrease. Although the raise caused foreign investors to flock to it, a strong currency resulted in the falling price of the most royal of metals.

All of this shows that the state of gold is unlikely to change anytime soon. For that to happen a further rise in inflation with a shift of policy would be required, but Powell already reiterated that he won’t budge. It is time to acknowledge the change in times. More effective actions against crises put gold’s place as a safe haven at risk and it might be time to throw it out. Naturally, it doesn’t mean the mineral became obsolete, but it’s probably better as a nice ring than a part of your investment portfolio.


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