My answer is: smile. In a world of deflation, risk aversion, financial crisis and policy gridlock, it is understandable that some investors will wish to move into gold and other ‘safe haven’ assets such as the Swiss franc. This is even more so as the opportunity cost of investing in gold has collapsed, with record-low central bank interest rates. Remember, gold has no yield so you need to sell some periodically to gain an income.
The price of gold can also rise in other circumstances, namely when inflation risks mount, and excess liquidity seeps into financial assets, including commodities. On those occasions, some investors want a store of wealth, and the gold price rises.
Today, the turnaround in the gold price suggests we are in the middle, not the end, of the smile. Yes, there are some fears about deflation, especially in parts of Europe, but conversely the Bank of Japan is trying very hard to escape a disinflationary world, and the Fed shows it remains vigilant. Yes, there are some fears about inflation, especially in countries such as the UK or India. However, most of these relate to commodity or regulated prices, while core inflation pressures look very much under control in a world of high unemployment and spare capacity.
This analysis is important not just for gold or other commodities, but for broader asset allocation questions. We are in another Goldilocks environment, not too hot and not too cold. Global growth is decelerating, but a major recession looks unlikely, and this would need to appear to damage confidence in corporate earnings or cause a surge in bond default rates.
Policy uncertainty is high – will Europe agree to a financial transactions tax? – but the biggest risks seem at bay for now in the US, China or Europe. Politicians are learning their lesson and proving more flexible.
Time is a great healer, of course. Six years on from the start of the US housing market collapse it is turning around. Four years on from the UK banking disaster, there is talk of light at the end of the tunnel. Financial repression is working as debt levels are slowly brought under control, painful though that is for many firms and households.
Meanwhile, investors should follow the clear signals from central bankers that in a world of low inflation and low interest rates, they need to seek income opportunities from equities, credit and real estate. Just remember the smile.
