Gold Takes Beating as Deflation Signs Grow
Gold has been under pressure today, with spot gold (XAUUSD) slipping to around the $1670 mark from around $1700 this morning. Many in the market have been extremely bullish on gold over the past few months, and for good reason!
Indeed, since the start of December, Gold has rallied from beneath $1500! Burgeoning global risks in the form of the global Covid-19 pandemic have supported the safe-haven metal, which has also benefited from increasingly expansive global central banking policy.
However, the is one fundamental factor that may force the gold bulls into retreat.
First, it is key to understand gold’s relationship with inflation; the precious metal is not only seen as a safe haven, but also as a hedge against inflation. In other words, no matter what happens in the real economy, gold is likely to keep its value as there is only a limited supply. The same cannot be said for money; central banks can print money, eroding its value.
Therefore, in an environment of high inflation, gold tends to do well. Or when central bank’s pursue policies that may result in high inflation (i.e. money printing), gold tends to do well.
However, despite all the stimulative action being taken by global central banks at the moment, the Covid-19 pandemic risks throwing the global economy into deflation. I.e. negative inflation.
With consumers locked away at home and with many of them now out of work, producers of goods are likely to be forced to axe prices in order to compete.
In such an environment, money literally gains value just being left on its own. The incentive to invest in gold as a hedge against inflation is, therefore greatly diminished.
Adding to the risk of deflation is the recent, sudden decline of oil prices. With some futures contracts now trading in negative territory (see Ken’s earlier blog), downwards pressure on inflation is intensifying.
By the end of the year, it seems likely that much of the developed world may be in deflation.
Gold bulls beware!!
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