One of the more surprising developments since the start of the year has been the rise in the price of gold. In the past, the argument has often been made that gold is a safe haven. I have always had issues with this view, considering the volatility of the price of gold and the absence of a yield: the return for the investor is entirely driven by price changes since the time of purchase. Another argument often used is the inflation hedging characteristics. Again, this is questionable. The following chart shows the evolution of the market based inflation expectation in the US over a 5 year period starting in 5 years’ time. This series if often used as a proxy for inflation expectations of households or corporates although the differences with survey based inflation expectations can be considerable. The black line shows the price of gold. Visual inspection shows that the correlation is weak although quite often there have been short periods where it was high.

2016 03 04

Since the start of 2016, inflation expectations have declined but the price of gold has increased, so the correlation has been negative. In addition, equity prices have also declined (the blue line shows the S&P500). A possible interpretation is that gold ended up ‘being the only game in town’ with risky assets like equities, corporate bonds or emerging bonds under pressure. One might ask “but what about US treasuries?” The story here is that the decline in bond yields cause an increase in their price sensitivity to interest rate changes (the duration is getting longer) so if the market would start to price in a higher likelihood of a Fed tightening on the back of stronger data, this would impact the value of the bonds. It implies that on a relative basis compared to treasuries gold becomes less risky than it used to be. Compared to Japan and several European bond markets where yields up to certain maturities are negative, gold can even be considered as a carry trade. This is somewhat ironic considering it doesn’t offer a yield, but one can argue that a zero yield is better than a negative yield.

Very recently, things have changed again and we seem to have moved into a ‘risk on’ environment: the S&P500 is up as are inflation expectations and the rally in gold has stalled. It seems markets are driven by correlation strategies, which overall makes them more volatile. Data surprises and words of central bankers become even more important than before.