Gold is considered a hedge against market turbulence. In times of uncertainty, it serves as a global safe haven — a constant that has always held value as a tangible asset. Historically, the price of gold is driven higher when investors seek safety and shelter from market risk.
Since establishing a 5-month low of $1,241.70/oz. on Dec. 12, gold has surged more than 6 percent, approaching the 2017 high of $1,355.30/oz. set last September.
But what has been driving investors into the comfort of the yellow metal? There doesn’t appear to be much, if any, uncertainty in the stock markets; just a continuing pace of new record highs.
In 2017, the S&P 500 gained 19.4 percent, the Dow Jones Industrial Average rose 25.1 percent and the tech-heavy NASDAQ Composite Index gained a hefty 28.2 percent. In the first week of 2018, in just four days of trading, the Dow gained 2.33 percent, its best start to a year since 2003, a year in which the Dow rose 25 percent. The S&P 500 and NASDAQ also had their best start since 2006.
The stock markets have also been free of volatility or significant pullback. In fact, the VIX Volatility Index, the preferred gauge of measuring volatility and uncertainty in the stock market, recorded its lowest yearly average in history. Known as the “fear indicator”, the historical average of the VIX is around 20. But in 2017, the average index measure was just 11.09, reflecting a record period of calm in the stock markets.
Despite the rise and relative calm of the stock markets in 2017, the price of gold surged 12 percent. Furthermore, this surge was in an environment of rising interest rates. The Federal Reserve’s three hikes to the benchmark fed funds rate in 2017 are seen as a precursor to three more rate increases this year. Gold prices are extremely sensitive to changes in interest rates. As interest rates rise, gold tends to decline. Since gold bears no dividend or interest payments, when interest rates increase, investors typically shed non-yielding assets such as gold in search of higher yields in other types of investments.
The flood of investor cash into gold suggests an underlying anxiety on the sustainability of stock market gains and the continued health of the U.S. economy. Despite an exceptionally strong labor market and a growing U.S. economy, skeptics point to the historical record of economic performance following a cycle of interest rate hikes. According to Fed data, of the 19 interest rate hike cycles dating back to 1914, 16 have ended with the U.S. economy in a recession.
Obviously, the past is no indication of the future. Stock market proponents remain bullish, citing the recent signing of President Trump’s tax cut bill, expected to further boost corporate profits and economic growth. But the Fed’s rate hike agenda will indeed temper economic growth, as the rising cost of short-term debt curtails consumer spending – the key driver of the American economy.
The Fed insists its rate hike agenda is necessary – that a measured pace of rate hikes provides a gentle tapping of the breaks on a growing economy that prevents it from overheating. Skeptics maintain their doubts on the Fed’s ability to implement its rate hikes without significantly disrupting economic growth. For now, that concern continues to be satisfied in the comfort of gold.