Gold: it tells the true story of the UK economy, is it time to dip in?

The price of gold hit an all-time high in September, it has since fallen 10 per cent. This may come as something of a surprise to you, so let me explain why and why I think it may rise further still.

Article updated: 20 November 2019 12:00pm Author: Michael Baxter

Of course, I sort of cheated. When I say gold hit an all-time high in September, I am referring to its sterling value. Measured in dollars, gold did indeed rise sharply over a three-year period, peaking on September 4th at $1,557.21 a troy ounce, but that was nowhere near a record high, which is in fact $1,896.5, set in September 2011. It has fallen back recently, down by around five per cent in the last three months or so, when measured in dollars.

I find the divergence between the dollar and sterling value of gold fascinating. If you hold by the view that the gold price reflects true long-term value of goods and services, then in fact it all rather suggests that UK inflation has been much greater than is generally supposed.

For what it is worth, I am not sure that gold really does reflect any true underlying value, but even so, the sterling strength of gold could be significant.

Let’s pause for a moment. Forget about the UK and ask why did the dollar price of gold enjoy such a strong rally? And why has it fallen back in recent weeks?

Central banks seem to provide the main reason for the surge in the gold price; they have been buying it on a mass scale.

India provides another driver — demand for gold as an item of jewellery is significant in the region, so a growing Indian economy boosts gold.

The gold price has fallen back in recent weeks in part because of weakness in the Indian economy and also because central banks have either paused for breath in buying gold, or feel they have enough.

Underpinning this has been fears about the global economy; trade and currency wars for example. The flipping of the yield curve (when yields on longer term treasuries fall below shorter term yields) may be a symptom of this deeper malaise.

But traditionally, gold is seen as a safe refuge against inflation. And sometimes, the markets get it into their heads that inflation is in for a comeback, so the gold price goes up.

It happened at the beginning of this decade, when a narrative emerged that quantitative easing would lead to runaway inflation. The narrative was wrong; it was built on a misunderstanding of what quantitative easing was and what the underlying causes of global inflation/deflation were.

Inflation has been so modest over the last ten years or more because globally there was a chronic shortage of demand relative to global potential supply.

This time around things are different in one respect. If trade wars escalate and we really do see a reversal in globalisation, then global potential supply will fall, demand relative to supply may thus rise and that may be inflationary.

After years of near deflation, I am cautious about predicting rising inflation, but for the reasons outlined above, I would say inflation is a bigger risk right now than it has been for some time. For that reason, the gold price may have further increases to follow.

Return to the UK, however, and a different story emerges. It is clear austerity is dead. Both Tories and Labour seem to think they have found money trees. Well, given that the UK government can borrow so cheaply, maybe they have. But it seems to me that the most likely result of both Tory and Labour plans is a fall in sterling.

That takes us back to gold. If sterling falls, and the dollar price of gold remains unchanged, then the sterling price of gold will rise. But if the dollar price of gold rises, for the reasons outlined above, then the sterling price should have a much more significant increase.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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