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Is gold a safe haven for investors?

The price of gold has risen in recent years, highlighting the role of this precious metal as a stable investment. While the value of gold is resilient and protected from inflation, its stability is not guaranteed in times of crisis.

The value of gold is stable. It provides protection from inflation; it can diversify investors’ portfolios; and it is typically resilient to financial and economic crises. There has always been strong demand for gold (see Figure 1).

Figure 1: The price of gold

Source: The Royal Mint

These characteristics make gold a safe asset. Indeed, fuelled by geopolitical unrest and higher inflation around the world, gold prices have recently reached an all-time high of over £1,600 per troy ounce (a unit of weight used for precious metals equivalent to 31.1 grams).

A long-standing idea is that gold provides a safe haven or a hedge against inflation and the potential volatility of other assets’ prices (Baur and Lucey, 2010; Baur and McDermott, 2010). A safe haven is a long-term investment that is expected to retain its value or even increase in value during times of market turbulence.

A hedge, on the other hand, is a temporary investment that is made with the intention of reducing the risk of adverse price movements in an asset. As a result, gold – both as a safe haven and a hedge – is a form of insurance.

Experts say that gold is a good safety net – for example, during the Covid-19 pandemic – one that protects money from various market ups and downs (Beckmann et al, 2019; Akhtaruzzaman et al, 2021; Konstantakis et al, 2023; Tanin et al, 2022; Salisu et al, 2021).

But when it comes to fighting inflation, gold's track record is a bit hit and miss. Studies show mixed results. Some research suggests that gold doesn't always follow inflation closely (Salisu et al, 2020), while others say that it can protect against inflation if investors are patient or depending on the economic situation (Aye et al, 2017; Shahzad et al, 2019).

The recent rise in gold prices is linked to increased inflation and the weakening dollar. But, perhaps more importantly, armed conflicts increase global economic uncertainty, adding more fuel to the gold rally.

Gold and uncertainty

Gold and uncertainty are strongly linked. One study highlights that during big global crises, when things feel most uncertain, you can expect gold to do well (Boubaker et al, 2020).

Other work has discovered that gold stands out from other precious metals in how it reacts to these uncertain times (Baur and Smales, 2018). Specifically, gold prices go up as geopolitical tensions increase – but as these tensions rise, the riskiness of gold as an investment remains unchanged.

Put differently, when global uncertainty increases, investors’ flight to safety does not make gold markets inherently more volatile.

On the other hand, gold’s role as a hedge or safe haven is conditional on the intensity of the uncertainty and whether the gold market is bearish – expecting a downturn – or bullish – in an upswing (Bouoiyour et al, 2018).

In any case, across the board, gold is an important commodity in the practice of hedging and diversifying investment portfolios (Triki and Maatoug, 2021). Figure 2 compares gold returns with the total equity return of the New York Stock Exchange (NYSE) composite index and the US ten-year treasury yield. Since the 1990s, gold has consistently outperformed US government bonds (which are traditionally considered a safe haven), but it has not managed to deliver the same performance for investors as equities/shares (which are traditionally considered to be a riskier investment).

Figure 2: The performance of gold compared with bonds and equities/shares

Source: Refinitiv (previously Thomson Reuters)

Gold and economic policy uncertainty

The link between gold and uncertainty is strong, but this seems to be especially true for uncertainty stemming from economic policies. Economic policy uncertainty is usually defined as that stemming from fiscal policy (related to taxes and public spending), regulatory policy and monetary policy (Baker et al, 2016).

Gold is an effective hedge against these sources of uncertainty (Qin et al, 2020). More specifically, gold markets remain unaffected by unexpected shocks to economic policy uncertainty (Huynh, 2020).

Conversely, gold prices are less likely to fall when economic policy conditions improve (Bilgin et al, 2018). In times of crisis and political instability, it seems that gold continues to shine, acting as ‘a barometer of global risk’ (Su et al, 2022).

Gold in history

Over the past 100 years, gold has yielded a 2.1% average annual return. Over the same period, the Dow Jones Industrial Average (DJIA), an index of the US stock market, has yielded a return of approximately 7.3% (see Figure 3).

More interesting is to examine when gold outperforms the stock market. Indeed, it has outperformed the DJIA in 43% of the years between 1925 and 2015 (see Figure 4, panel A).

Figure 3: The historic performance of gold

Source: MacroTrends LLC

This period contains events such as the Great Depression, the outbreak of the Second World War, the stagflation of the 1970s and the post-2000 era. Many of these coincide with recessions in the US economy (see Figure 4, panel B).

During recessions, the two-year average gold return outperforms the index by approximately 1.65%. Gold can also outperform the index outside of periods of economic turmoil. In 26 out of the 65 years without a recession, gold outperformed the index – by more than 13% on average (see Figure 4, panel C).

There is good evidence that gold acts as a safe haven even outside recessionary periods. This is especially true after the First World War and in the wake of events such as the Lehman Brothers bankruptcy or the 9/11 attacks on the United States (Boubaker et al, 2020; Baur and McDermott, 2016).

Figure 4: The relative performance of gold in times of uncertainty

Source: MacroTrends LLC and St Louis FED

In short, gold is seen as a reliable and solid investment over the long term, offering a buffer during crises and protection against uncertainty. This has sparked a growing movement advocating that countries should reconnect their currencies to gold, promising greater financial stability.

Alan Greenspan, former chair of the Federal Reserve Board (the US central bank), suggested in a 2016 interview that reintroducing a gold standard could be beneficial, remembering the late 19th to early 20th century as a booming economic era.

Some high-profile figures and institutions – including former US president Donald Trump, the American Institute for Economic Research and politician Ron Paul – also support this idea. At the end of 2023, congressman Alexander Mooney even proposed legislation to bring back the gold standard.

The interwar gold standard

So, was gold a safe haven when the gold standard was in place?

To answer this question, we turn to the time of the second gold standard (1925-36). During this period, countries across the world fixed their exchange rates and linked the value of their currencies directly to gold.

This meant that gold was an important policy instrument for governments and central banks. The fixing of exchange rates has the purpose of ensuring financial and economic stability for the members of the standard.

But because of the lack of strong international leadership, limited coordination between member states and the subordination of gold convertibility to domestic policies, the standard never delivered on its promise.

Further, when the UK left the gold standard in September 1931, it sent a shockwave through the global financial system (Obstfeld and Taylor, 1998).

During this period, adherence to the gold standard by countries was seen as a signal of financial rectitude or as a ‘good housekeeping seal of approval’ (Bordo and Edelstein, 1999).

Yet, what is often forgotten is that when gold becomes a monetary policy instrument, governments get involved in gold markets and exert control over them. There are plenty of examples of this.

In the UK, for example, the gold market was fixed via an auction (Harvey, 2008; O’Connor and Lucey, 2023). In South Africa – at the time the largest producer of gold – the government bought gold directly from the mines and by 1929, it had fully captured all gold production (Swanepoel and Fliers, 2021).

Further, in the wake of the UK’s departure from the gold standard, the Dutch government and its central bank seized control of the domestic gold market (Fliers and Colvin, 2022).

In 1933, the US government under President Franklin Roosevelt nationalised the country’s gold, seizing all gold bullion and coins (Holzer, 1972). This forced citizens to sell at below market rates and made private gold ownership illegal.

Ultimately, gold is a safe haven, and we are not wrong to think of it as such. There will always be a demand for gold, not least because its value is stable and it can provide protection from inflation and diversification for investors’ portfolios.

But while it can be resilient to crises, in turbulent events and periods, and with a government willing to protect its currency at all costs, gold might not be as safe an investment as you think.

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Author: Philip Fliers
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