The globe’s central banks have increasingly embraced unconventional monetary policies to stimulate economic growth and stoke inflation.
Despite the trillions pumped into markets and the banking system since the global financial crisis most developed nations’ sovereign bond yields continue to decline.
Negative rates like the Swiss National Bank’s minus 0.75% on deposits are no longer unchartered territory. Ten European countries have negative two-year note yields.
Benchmark German bonds are bobbing along at record lows, dipping even below that of Japan, long the poster child of deflation.
Most developed economies have no choice but to provide additional monetary stimulus.
The world’s second largest economy China looks in need of much more accommodation than the People’s Bank has provided so far.
The obvious exception here is the US. The Federal Reserve have been telegraphing a mid-year hike in rates for a while, but futures tell a different story.
Gold’s status as a hedge against inflation is long-established, but a new research note by Julian Jessop, Head of Commodities Research at Capital Economics, finds the metal can also thrive in a deflationary environment:
“It is certainly no coincidence that the surge in gold prices in the mid- and late-70s coincided with inflation spikes due to the oil shocks. Indeed, the record high for the real gold price was reached in 1980, when US inflation peaked above 14%. (See Chart 1.) What’s more, the surge in the gold price between 2009 and 2011 appears to have been correlated with a rebound in inflation expectations. (See Chart 2.)
“However, Chart 1 also shows that gold’s prolonged bull market from 2002 took place against a backdrop of generally low (and sometimes negative) inflation. Other drivers can clearly dominate. Indeed, it is not difficult to think of circumstances in which deflation could be positive for gold, many of which apply now. For a start, interest rates are more likely to be held close to zero or even cut into negative territory, minimising the opportunity cost of holding gold.
“And even if inflation is not an immediate concern, an extended period of ultra-loose monetary policy could still increase demand for gold as a longer-term hedge against currency debasement and future inflation shocks.”
Source: Capital Economics
Image by Camil Tulcan
