Gold's reality check

Investor's piled into gold as an inflation hedge and safe haven -now they face a dilemma

This article was published in Business Post on 18th July

After rising nearly 250% between October 2022 and January of this year, sentiment towards gold has shifted markedly. The metal was down 14% in Q2, its worst quarter since Q2 2013.  Having traded over $5,500/oz in January its now close to $4,000/oz, almost a 30% decline from the highs.

Many investors bought into gold on the view that it’s a store of a value, an inflation hedge and an asset that could be a diversifier for not only equities and bonds but fiat currencies as well. The question they face now is whether this marks just a temporary correction or a fundamental change in trend.“

A blow off top

With the benefit of hindsight, it is easy to say sentiment towards precious metals got to an extreme in January.  Not only had gold posted strong gains, but silver rose by nearly 250% between August and January, clearly an unsustainable move.

But the warnings had been in place for gold too. Technical indicators hit extreme overbought levels: as of the end of January gold was about 45% above its 200-day moving average. From that perspective, a 30% drawdown can plausibly be seen as a natural correction in a multi-year bull trend.

Indeed, in the last mega gold move in the 1970s, gold rallied 450% from its Jan 1970 lows to December 1974 and then declined by just under 50% between Dec 1974 and August 1976, before commencing a multi-year accelerated rise to January 1980.

The problem with gold

Arguably, the issue with gold is less about how it behaves and more about how it is perceived.

Labels like safe haven asset and store of value give an impression of safety and stability.  Yes the reality is gold is more volatile than most equity indices. A decline of 12% in a month or 14% in a quarter is not unusual, statistically, for an asset with that type of volatility.

Over the very long-term gold has retained its purchasing power and been a hedge against inflation, but it has gone through large up and down cycles. After the boom of the 1970s, gold prices fell 71% between 1980 and 2000.

For investors it creates a real dilemma. Gold’s low correlation to equities and bonds encourages a meaningful allocation to the asset, but a 30% drop is painful.

In theory diversification is the only free lunch in investing but at times it can certainly feel uncomfortable.

Shifting fundamentals

It’s important to put the current moves in context.  Even after the current drawdown, gold’s realised returns are strong.  Since 2000, spot gold has risen at an annualized rate of 7.9% and since Jan 2020 spot gold prices have risen by 16.1% per annum.

And from a fundamental perspective some of the factors which have been supportive gold in the last few years have paused or even reversed of late.

Central bank buying for reserve management, due to concerns about the US dollar, has been one of the big fundamental supports. Global central banks bought about 1,000 tons of gold p.a. between 2022-2025 up from an average of about 470 tonnes p.a. between 2010-2021. But this year some central banks have turned sellers as they have needed to monetise profits due to budgetary pressures.

The large rise in gold also brought the metal increasingly to the attention of retail investors; ETF demand picked up notably last year and into early this year. But there is nothing like price to influence sentiment and as soon as prices stopped rising, and showed signs of reversing, ETF demand slowed and ultimately reversed.

That partially reflected a changed macro back drop. A weaker US dollar and a perception of low US interest rates were other supports, and those two factors have turned from tailwinds to headwinds.

That said the big picture still looks positive. Although concerns about US dollar debasement have eased for now, the US debt/GDP ratio is above 100% and that is before the looming wave of increased spending in relation to entitlements in the next few decades is factored in. Politically, there is no appetite to address the fiscal deficit, suggesting the default will be more spending and potentially more money printing over time.

Meanwhile, economic growth has been solid in the US, but the economy has become increasingly unbalanced and reliant on the AI boom.  But if the AI capex cycle runs its course, at some point equities could fall and the wealth effect from rising stock prices would go into reverse. In that scenario we’d likely see even higher fiscal deficits and lower interest rates – both positive for gold.

How to size it

So, is this a temporary correction or a fundamental change in trend?

History suggests the former is more likely. Gold's boom-bust pattern has repeated for years, and a 30% drawdown after a 250% rally is well within that pattern, not outside it. In fact, another 20-25% decline from here wouldn't be unusual either, and wouldn't necessarily change the longer-term case.

But that's the point. Gold is sold to investors on its label: safe haven, store of value, inflation hedge. But it should be sized on its behaviour: a genuinely volatile asset that can swing 30% in a matter of months. Investors who understand that distinction can hold gold through periods like this one. Those who don't tend to chase it at the top and sell out in the drawdown.

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