EXPLAINED: Why are gold prices rising?

 

The Surprising Surge in Gold Prices: An Institutional Investor Phenomenon

The Gold Rush Without a Crisis

The gold market has been making headlines lately, with the buying price of gold futures hitting multiple record highs this year. Since January 2nd, gold has risen more than 14% in value, outperforming the Dow Jones, NASDAQ, and S&P 500 indices, which have also reached new all-time highs. This surge in gold prices is puzzling, as it is happening without a recession or a pandemic, and with inflation and interest rates expected to fall.

Traditionally, gold has been viewed as a safe investment, as it has been treated with intrinsic worth and is less influenced by the passions of the moment. The last times gold prices peaked were following the 2007-2009 financial crisis and the onset of the COVID-19 pandemic. However, the current rally in gold prices is not driven by the same factors that have historically fueled the demand for the precious metal.

The Institutional Investor Phenomenon

According to Professor Campbell Harvey, a finance expert at Duke University and co-author of "The Golden Dilemma," the current surge in gold prices is primarily driven by institutional investors, such as hedge funds, rather than retail investors. In the past 10 months, there have been negative flows or outflows from gold exchange-traded funds (ETFs), while there has been an increase in Bitcoin ETFs.

Professor Harvey explains that institutional investors are likely speculating on the price of gold, seeing it as a lagging investment compared to the spectacular performance of stocks like Nvidia. These investors are engaging in a "momentum trade," where they buy more as the price of gold continues to rise, fueling the upward trend until it eventually stops and reverses.

The Unreliable Nature of Gold as a Hedge

The traditional rationale for investing in gold has been its ability to serve as a crisis hedge or an inflation hedge. However, Professor Harvey's research, which uses thousands of years of data, suggests that gold is quite volatile, with its movements up and down being as sharp as the S&P 500. This means that gold is somewhat unreliable in its ability to provide the expected crisis or inflation hedging properties.

In fact, the professor's research shows that even when gold prices have risen before or during crises, such as the global financial crisis and the COVID-19 pandemic, the precious metal has subsequently dropped sharply. This further undermines the perception of gold as a reliable safe haven asset.

The Risks of Buying Gold at All-Time Highs

Professor Harvey's research also examines the historical performance of gold when purchased at all-time highs, which is the current situation. The findings suggest that the expected returns over the next 10 years are quite modest, indicating that investors who buy gold at these record levels may not see the kind of returns they might expect.

This raises questions about the sustainability of the current gold rally and the potential risks for investors who are jumping on the bandwagon. The institutional investors driving the surge may be engaging in a speculative "momentum trade" that could quickly reverse, leaving those who bought at the peak with disappointing returns.

Conclusion: Cautious Approach Warranted

The sudden and unexpected surge in gold prices has taken many by surprise, as it is occurring without the traditional drivers of a crisis or high inflation. Professor Harvey's insights suggest that this rally is primarily driven by institutional investors, who are speculating on the price of gold rather than seeking its traditional safe haven or inflation-hedging properties.

Given the volatile nature of gold and the risks associated with buying at all-time highs, investors would be wise to approach the current gold market with caution. The momentum-driven nature of the institutional investor activity could lead to a sharp reversal, potentially leaving those who jumped in late with disappointing returns. As always, thorough research and a well-diversified investment strategy are key to navigating the complexities of the gold market and other financial assets.