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Gold investors always want more! Last year saw sharply higher inflation around the world, a war in Europe, with stocks and other assets down: a perfect trifecta for gold.

Instead gold was down for much of the year. Why did we not see the sharp move in gold that many predicted? The metal’s performance left many gold investors disappointed and frustrated for most of the year.


There are misconceptions here. Most importantly, the gold price does not necessarily move higher with inflation. In fact, its correlation with rising prices is rather weak. For one reason, where prices are going up, the market fears central bank tightening action to stop inflation, and that is negative for gold. Gold may go up in nominal dollars at the onset of an inflation period, but in real terms and relative to other assets, gold does not shine in inflations.

This was demonstrated clearly in Prof. Roy Jastram’s pathbreaking book, The Golden Constant. In a study of annual prices going back to the 13th century, Jastram demonstrated that gold performed better in deflationary periods than inflations.

As for wars and geopolitical events, the impact on gold tends to be short lived.  Often, indeed, gold moves up during the gathering storm, as a crisis develops, and often peaks at or very shortly after the feared event.  This was seen clearly with the Russian invasion of Ukraine last year, when gold peaked within a weak of the tanks rolling in.

Gold often goes up when stocks are weak, but it’s a little more complex than that. In fact, it goes down almost as often, and there is very little correlation at all.  Generally, three things determine whether gold goes down with stocks: had gold and gold stocks appreciated in the period before the decline– if so, they are more likely to go down with the broad market; are the gold stocks expensive–if so, they are more likely to go down; and what type of market decline–in a sharp sudden decline, think 1987, gold and gold stocks will fall as all assets are sold. Similarly, in a liquidity driven decline, gold will fall in a search for liquidity.


Apart from the above, there were two main reasons why gold did not move sharply higher last year, in US dollar terms at least. The relentless strength in the U.S. dollar was a very strong headwind. And rising rates and QT around the world leading to asset deflation.

Gold, as we know, performed quite well when priced in most currencies. Brits counting in pounds saw it up almost 12% for the year.

Even in U.S. dollar terms, at the end of the year, gold was essentially flat, holding up well in the face of a dollar that was up over 8%. It performed its job, therefore, in holding its own. In a period of general asset deflation, simply not losing made it a winner.

If gold is not correlated with current inflation, if geopolitical events have only a short-term impact; and if gold may or may not move up when stocks fall, what does move gold? These are the two key determinants of gold’s performance over more than a very short period: the currency and interest rates.

The gold price in dollars has a clearly inverse relationship with the dollar. This is not surprising, since gold is money. As a bull market gathers strength, then we can see gold move up in terms of all currencies even if the dollar is relatively strong.


The relationship with interest rates is a little more complex, but not much. In a period of rising real rates when the market expects rates to continue to move up and inflation to be beaten, gold will be weak. But rates, even real rates, can be high and moving up, and gold can still appreciate. This happens if rates, though high, are not above the rate of inflation, and if the market does not expect rates to continue to move up.

We can see this distinction clearly in the 1970s. Federal Reserve Chairman Arthur Burns, widely viewed today as a weak chairman, was repeatedly raising rates, but always lagging inflation and the markets had little confidence in his ability to kill inflation. When Paul Volker came in, however, even though inflation was far higher than under Burns, rates started moving above the rate of inflation and the market believed that Volker would continue until the job was done, regardless of the short term cost to the economy. He was fortunate in having a president, Reagan, who supported him.

Today, interest rates are still well below the prevailing rate of inflation, even after the decline we have seen in the last couple of months. This is true in the U.K. and Europe as much as the U.S. The market, the gold market at least, is increasingly of the view that the Fed will not see the job through, and certainly not without a serious recession that might induce the Fed to reverse course. A pause before the job is done would be extremely positive for gold. That is why gold moved up in the last few of months, even as inflation was coming down.



Investors are beginning to realise that the Fed will not achieve 2% maximum inflation, and certainly not without a recession. Monetary policy works with long and variable lags. The most interest rate sensitive sectors, such as housing and autos, feel it first. Other sectors come later. Retail sales for example held up very well throughout 2022, leading many to point to them as support for the argument that the economy remained robust. But if prices are up, retail sales should be up equally if consumers are maintaining their consumption. More significantly however, is this: while retail sales were holding steady, savings were eroding and later credit card balances appreciating rapidly; now, we have started to see card write-offs shoot up, to 20-year records. If people are buying, but are doing so from savings and on credit card debt, then that obviously cannot continue for very long. Consumers, particularly at the lower 50% of income, are tapped out.

Some investors are concerned that a recession will be bad for gold and gold stocks. Not necessarily! Looking at the last seven recessions in the U.S. back to 1973, gold rose in all but one of those recessions (and in 2001, it declined by less than half a percent). Gold stocks outperformed the broad market in a majority of all recent recessions, since 1990. If we look at gold and gold stocks during and in the six-month period after recessions, we find positive performance in all but two of those periods; the first being the sharp Volcker recession of 1981 which came after a period of extraordinary performance for gold stocks; and the second, the short recession of 1990, which coincided with the onset of a period of heavy central bank selling. If, however, we see a stagflation, with persistent inflation and a sluggish or even declining economy, then we can expect gold and gold stocks to shine.

This scenario of persistently high inflation and a sluggish economy is the famous stagflation, such as the US experienced in the second half of the 1970s. It is a very favourable economic environment for gold and gold stocks.

We are also seeing a strong boost in central bank buying, the result of the weaponisation of the dollar and the global banking system by the U.S. Suffice to say now that this is going to be a long-term trend and clearly very bullish for the metal.



Lastly, let’s look at the gold stocks: they remain very undervalued, despite a strong rally since mid September, that saw the index (XAU) up over 50% at one point.

· They have lagged bullion for a decade now after moving more-or-less in tandem for decades (the stocks multiplying the metal’s moves, up or down, by three or four times)

· Gold stocks are undervalued on an historical basis, trading below average valuations, and by many metrics, such as price to free cash flow, at close to the lows.

· Gold stocks are undervalued relative to the broad market, an unusual circumstance.

These under-valuations come at a time when the gold sector is in a strong shape, in aggregate net cash positive, with strong margins (not withstanding rising costs), and a powerful outlook for the metal. That the stocks should be so inexpensive in such a positive environment is a compelling buying opportunity.   EG

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