Why gold is at an all-time high
Gold is trading at all-time highs after breaching levels not seen since the yellow metal's dramatic rise and fall in the 1970s and 80s.
Interestingly enough, some of the factors driving today's gold rally are similar to the 1980s.
Back then high levels of inflation set the trend for gold prices while a combination of geopolitical uncertainty and aggressive US federal fund policy led to the gold prices short-term and dramatic spike.
Gold and high inflation
Today the economy has been challenged by a post-COVID spike in inflation. And while early gains in bringing inflation back to more normal levels saw the gold price come off, recent stubbornness has helped drive the price higher once again.
Similar to 1980, current geopolitical tensions in the Middle East and a narrative of higher for longer interest rates have pushed gold to its most recent peak as investors seek a safe haven.
However, what may be more insightful for investors are the dissimilarities to gold's 1980 run as there may be more structural reasons at play and support for today's rally.
Currently the gold price is bucking the trend of its greatest historical drivers - gold's inverse relationship with real yields and the US dollar.
When government bond yields, after adjusting for inflation expectations (i.e. real yields), are increasing, the opportunity cost of holding a non-income producing asset, like gold, also increases. In this scenario investors are paid more to use bonds as an alternative to gold. As a result, gold becomes relatively less attractive as an asset when real yields are high and/or rising and more attractive when real yields are low and/or falling.
Gold has also historically been used to hedge against a weakening US dollar. Gold's value does not rely on the performance or stability of the US government, as a result, it is arguably seen as "the currency of last resort" by many investors.
The USD strength and rise in real yields we are experiencing today along with a record gold price points to other structural factors supporting prices.
Central banks buying up gold
In recent years we've seen central banks, particularly from emerging markets like India and Turkey, buying record amounts of gold.
For countries running large current account surpluses, gold is an asset that allows them to diversify their reserves away from U.S. dollars and Treasuries, and therefore reduce the potential leverage the US government may seek to exert over them in the geopolitical arena.
If a government does wish to reduce their reliance on the United States, there seem to be few (if any) practical alternatives to increasing their investment in gold.
More recently, there has been demand from various central banks, with China being a major gold buyer of note. China has seen demand from both the People's Bank of China (PBoC), which has now increased its gold holdings for a 17th consecutive month, and also from households looking to protect their wealth against a vulnerable domestic property market.
What it means for Aussie investors
For Australian investors looking to invest in gold an important consideration is currency hedging, as gold is priced in US dollars.
The correlation between gold returns and changes in the AUD/USD spot exchange rate remains positive over the long term, so investors looking to capture further strength in gold might be doing themselves a disservice by being unhedged from a currency point of view.
Aside from the positive weekly return correlation, the largest moves historically in the US$ gold price have occurred during periods of significant broad USD weakness and AUD strength.
Another way for investors to gain exposure to gold is through the picks and shovels, notably gold miners.
It's been a tough past three years for gold miners, with higher production costs and a rising cost of capital taking its toll on the sector.
However, with the US rate-hiking cycle now likely at an end, the companies that have come through the other side are likely stronger and better able to exploit the natural operating leverage they have to any gold rally.
Indeed, the breakout in gold miners over the past month has been notable, and it's a sign that the sector is now more resilient than before and well-positioned to be one of the biggest beneficiaries in global equity markets from ongoing strength in precious metals.
And similar to spot gold, the biggest rallies from gold miners historically have been during periods of AUD strength, making it sensible to hedge exposure from a currency point of view to get the most out of this trade.
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