Gold has usually been viewed as a hedge against inflation yet we are seeing gold spike up since last October even while deflation fears have increased and inflation number have been on the decline. Now gold could be rising under the view that higher inflation is around the corner, but there is little to suggest that inflation will be increasing in 2009 in current numbers.
The cost of gold storage has declined with interest rates approaching zero so the penalty for holding gold while you wait for inflation is less. The expectation for inflation from a longer horizon can be embedded in gold prices given the low cost.
We think that gold is now actually being a surrogate for sovereign credit risk. This is goes back to the old story that gold is an alternative store of value but with a different twist. This alternative store of value story would be that if all countries become riskier than all currencies have the potential for being debased. Now a currency price is a relative price between two monies but if you do not know which currency will be less risky you may choose to store value in another alternative asset, gold.
Does this story fit the facts. A simple analysis suggests that it does. First, the price of gold increases dramatically during the first wave of the crisis in August 2007. This continued until March 2008 when the Bear Stearns bail-out occurred. Gold prices actually fell during the big oil run-up in the Spring and summer of 2008. While other commodities continued to fall, gold prices rose first with the AIG and Lehman problem and then with the talk of further country risk from fiscal crises.
Gold has increased with the increase in default risk across countries. In fact, the correlation with sovereign risk has been very high more so than any measure of current inflation. Gold has also moved with expected inflation embedded in the difference between nominal and TIPS bonds, yet general riskiness across currencies based on sovereign risk may be a better measure.
The cost of gold storage has declined with interest rates approaching zero so the penalty for holding gold while you wait for inflation is less. The expectation for inflation from a longer horizon can be embedded in gold prices given the low cost.
We think that gold is now actually being a surrogate for sovereign credit risk. This is goes back to the old story that gold is an alternative store of value but with a different twist. This alternative store of value story would be that if all countries become riskier than all currencies have the potential for being debased. Now a currency price is a relative price between two monies but if you do not know which currency will be less risky you may choose to store value in another alternative asset, gold.
Does this story fit the facts. A simple analysis suggests that it does. First, the price of gold increases dramatically during the first wave of the crisis in August 2007. This continued until March 2008 when the Bear Stearns bail-out occurred. Gold prices actually fell during the big oil run-up in the Spring and summer of 2008. While other commodities continued to fall, gold prices rose first with the AIG and Lehman problem and then with the talk of further country risk from fiscal crises.
Gold has increased with the increase in default risk across countries. In fact, the correlation with sovereign risk has been very high more so than any measure of current inflation. Gold has also moved with expected inflation embedded in the difference between nominal and TIPS bonds, yet general riskiness across currencies based on sovereign risk may be a better measure.
1 comment:
Great points. The Tips mkt has been a tough guage as the shorter dated bonds have years of inflation imbedded in them. That's getting stripped out <5 years as the projections are so low. A better guage, in mho, is the 5y forward 5y breakeven. (USGG5y5y Index on Bloomberg)as it's rallied ~130bp this year alone.
Your points on the sov risk are well taken. If the US and UK take these bank assets on balance sheet their respective cds spreads will look like Ireland and Austria...
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