Boom and bust: is gold trapped in a cycle?

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old is typically considered among the safest of investments, where consistently high demand and a reputation of stability have helped create a haven asset that investors flock to in times of economic crisis. Research from Macro Trends shows that the price of an ounce of gold has barely changed over the last decade, increasingly marginally from $1,685.70 in March 2011 to $1,698.50 in March 2021.

While there have been fluctuations in the price over this period, the fact that the value of gold has, in broad terms, remained consistent through the fallout of the 2008 crash, the 2015 oil price crash, and now the Covid-19 pandemic, is an encouraging sign for investors.

Yet this stability comes with a drawback, an intrinsic instability that could threaten its position as the prototypical safe haven asset. Gold tends to perform worse as surrounding economic conditions improve, as investors move away from the reliable commodity of gold and back towards more lucrative and riskier investments as confidence in the economy improves.

Bloombergreported in February of this year that the gold price reached a two-month low following economic recovery amid the pandemic, with its largest annual gain in a decade set back by a 6% fall in value in the first two months of the year.

While these bumps in the road have not derailed gold’s value, or indeed reputation, as a safe investment, they have created an interesting dynamic.

Worse economic conditions lead to greater investment in gold, while improved economic conditions drain its value, making gold a unique mineral and condemning it to cycles of booms and busts that mirror that of the broader economic landscape.

Gold has a number of unique characteristics that make it an ideal safe haven asset. The simple fact that it predates modern forms of currency, and acts as a counterbalance to the power of currencies such as the US dollar, means it will likely always hold a position unlike any other commodity.

Beyond this, it has a number of favourable traits. It is common enough to be a reliable source of value, but not so common that this value is eroded, with the World Gold Council reporting that the world’s total gold reserves sit at no more than 165,000 metric tonnes. It also holds dual roles, as the focus of investment and more tangible products such as jewellery, which give the metal importance in two distinct areas of economic activity.

“Gold is different to other commodities as it is also used for investment purposes and not simply to be consumed, although a significant share of output is used to make jewellery,” explains David Kurtz, a mining analyst at GlobalData. “As supply is limited, it tends to retain its value and when stocks are falling and there is uncertainty in the market, gold is considered a good investment."

“While its position as a hedge against inflation is not perfect, inflation effectively reduces the value of cash, whilst gold’s value tends to be maintained, and so it is also considered a good investment during times of rising inflation.”

The stability of gold amid rising inflation is particularly pertinent at present, with the World Bank reporting that the global rate of inflation has generally increased over the last five years. The rate of inflation reached 1.393% in 2015, the lowest on record, but this has since grown to a peak of 2.421% in 2018, before falling again slightly to 2.117% the following year.

This reputation also helps encourage greater investment in gold, creating a virtuous cycle of widespread investment, which begets confidence in the commodity, which begets greater investment again. CNBC reported that gold reached its highest price point in nearly seven years in April 2020, at the heart of the Covid-19 pandemic, as investors looked for a source of stability and security amid a once-in-a-generation social and economic upheaval.

The Covid-19 pandemic has highlighted some of the more unpredictable elements of gold. While these fluctuations in price are unlikely to be repeated again, considering the extremity and abnormality of the pandemic, the underlying factors behind these fluctuations remain constant.

“As an investment option, gold prices will be higher when the economy is in turmoil and lower when it is booming, so investment in gold mining and exploration tends to rise when prices are high,” says Kurtz. “In contrast, it tends to be during times of economic prosperity that investment in other commodities increases, so the cycles are different.

“We saw [this phenomenon] at the end of the 1990s and start of the century when it fell to around $400 per ounce, when US GDP was growing strongly and there was strong private debt, and a dot-com bubble which later burst,” Kurtz continues, demonstrating how there is a historical precedent for sudden, counterintuitive fluctuations in gold price, albeit to a less extreme extent than has been reported in recent years.

This reversal of fortunes has been particularly prominent this year, with a decline in the price of gold countered by an increase in the influence of the US dollar, swinging momentum definitively in the favour of the latter currency.

According to Yahoo, the dollar index – which demonstrates the influence of the US dollar compared to other currencies – increased by around 1% in the first two months of this year, compared to a 5.7% decline in the price of gold.

This is the inverse of last year’s trend, where the dollar index fell by 14% and gold prices rose 27% in the last nine months of the year, creating an imbalanced value relationship skewed heavily in favour of gold that has since swung back the other way.

Considering these fluctuations, the challenges faced by the gold industry are intensified when compared with similar obstacles for other sectors. Chief among these is the risk of the world simply exhausting its gold reserves, with conflicting reports concerning the long-term viability of the world’s gold reserves.

On the one hand, figures from Statista suggest an optimistic outlook, showing that global gold reserves have risen from 51,000 tons in 2010 to 53,000 tons in 2020.

However, a 2019 report into the struggles of gold by McKinsey and Company was more pessimistic in its assessment, suggesting that the decline in gold reserves may already be upon us, as reserves have declined by around 26%, driven in large part by a 70% fall in exploration expenditure.

The fall in exploration spending is also driven by the fact that miners, across many commodities, are having to settle for increasingly impure ores, as many of the world’s more gold-heavy deposits are mined and processed. Companies have to spend more to find and process increasingly impure gold deposits, creating a gold industry that will only become less efficient over time.

“The challenges for gold have come from diminishing output from South Africa, where declining reserves as well as rising costs have seen gold output fall steeply from the highs of the late 1960s and early 1970s, as well as challenges in identifying high grade resources,” says Kurtz.

He further highlights how these challenges are already denting production in historic gold powerhouses: “Output is rising from countries such as Russia, Australia, Canada, and the US, but there are fewer and fewer large-scale opportunities.”

There is a positive in this assessment, with Alok Shukla, director of mining at GlobalData, noting that “diminishing gold metal grades and reserves will impact supply, with higher production cost per ounce, which will increase the gap between demand and supply”.

However, these potential financial benefits do not offset some of the more existential challenges facing the gold industry, those concerning diminishing reserves and falling ore qualities.