Since the end of the easy money era, gold is up more than 40 per cent, making it one of the few things worth owning.Rick Wilking/Reuters
John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).
Gold is soaring. Currently trading at more than US$2,500 an ounce, it’s up nearly a quarter since the start of the year and 7 per cent in just the past month. There’s seldom been a better time to own it – and that may be a warning.
At first, rising demand had been driven largely by central banks, particularly those in developing countries, looking to diversify their reserves away from the ubiquitous greenback. But more recently retail investors have got in on the action. When gold goes ballistic like this, it’s often the proverbial canary in the coal mine, telling us trouble lies just over the horizon.
To see why, we can go back to the timeline. When the pandemic erupted in 2020, central banks slashed interest rates to near zero to protect the economy. That triggered spectacular bull markets in asset prices. Then, at the end of 2021, when inflation took off in Western countries, Federal Reserve chair Jerome Powell famously announced that the time had come to retire the term “transitory.” With price increases by then proving more tenacious than central banks had anticipated, they all decided it was time to raise interest rates again. Early the next year, they started doing so.
That’s when the bull run on everything, from shares and real estate to meme-stocks and cryptocurrencies, came to an end. Since then, commercial real estate has crashed. Canadian house prices are down, on average, nearly 20 per cent. Stock markets across the developed world have been flat and even the U.S. market, which has been sucking in money from around the world, has risen at an annualized inflation-adjusted rate of only about 3 per cent. Bitcoin, the supposed digital gold, after rocketing nearly 600 per cent in the two years after central banks opened the money spigots in 2020, has moved sideways since then.
But the real gold? Since the end of the easy-money era, it’s up more than 40 per cent, making it one of the few things worth owning. It tells you something when a shiny rock that has almost no practical or industrial use whatsoever, and produces nothing, has become the hottest thing going.
Specifically, it tells us that things may not be quite what they seem. To judge from the breathless commentary on the business channels and Twitter, central banks have squeezed the pips until they squeak. Look closely, though, and you see they haven’t. Despite high interest rates and the shrinking of balance sheets by central banks, by standard measures financial conditions actually remain pretty loose. Because central banks have put implicit floors under asset values, intervening whenever things get rocky – say, during Britain’s bond fiasco in the fall of 2022 or the failure of Silicon Valley Bank last year – financial institutions have retained the confidence to keep money moving.
That’s why a market supposedly on its last legs can rally as strongly as it did last Friday when Mr. Powell said lower interest rates were coming down. Gold prices suggest investors think the screaming about an impending collapse is play-acting, designed to get central banks to throw cheap money around once again.
Now that interest rates are falling, things could proceed a few different ways. Central banks could do what they keep saying they’ll do and move methodically, following the data. They’d thus cut interest rates less, and less frequently than investors currently expect. In that case, we’d likely see asset prices fall further, or at least keep moving sideways, continuing to lose value in real terms.
Alternatively, things in the economy could turn much worse. In that case, central banks could cut as aggressively as investors currently demand. But that probably wouldn’t rescue asset prices, since profits would likely fall in a recession. That’s actually the typical course in a cycle of monetary easing – that asset prices come down.
A third possibility, the one investors dearly hope is true, is that the economy enters a soft landing of low inflation amid steady growth, but central banks nevertheless slash interest rates sharply, triggering a new bull market. That’s what pricing in credit markets suggests investors are expecting.
Yet why central banks would cut steeply when the economy is running smoothly isn’t clear – if it ain’t broke, why fit it? Meanwhile, a big asset rally in a healthy economy would further run the risk of feeding inflation back into the economy.
Regardless, what’s clear is that investors don’t yet believe the repeated insistence of central banks that cheap money is a thing of the past. Until then, gold remains a safe haven – a hedge against either resurgent inflation or falling asset values. It will probably stay that way unless and until it becomes inescapably clear that the era of cheap money really is behind us.
And that probably won’t happen before asset prices take it further on the chin. Investors beware.