Why Gold Prices Have Been on the Rise

SMITH BRAIN TRUST – The price of gold has risen by more than 30% in the past 12 months, and has outperformed all other commodities traded this year under the impact of the COVID-19 epidemic. David Kass, clinical professor of finance at the University of Maryland’s Robert H. Smith School of Business, explains the economic implications.

Q: What is the logic, or key factors, behind this rise in the price of gold? 

Kass: The primary explanation for the recent sharp increase in the price of gold is the near-zero worldwide interest rates resulting from the liquidity being provided by central banks trying to offset the negative impacts from COVID-19 and the associated lockdowns. Investors seeking a positive rate of return have driven up the prices of many asset classes, including stocks and commodities.

Much of the global demand for gold is coming from gold-backed ETFs. In the first half of 2020, these ETFs attracted a record $40 billion, up from $5 billion in last year’s first half. Since these historically low interest rates are likely to be in place for at least another year with corresponding increases in liquidity, the price of gold may continue to increase.

Q: Does the rising price signal that a speculative bubble is forming? Do you see gold prices continuing to rise?

Kass: Gold prices may continue to rise until interest rates begin to increase in 2021 or later. At that time, the price of gold could decline sharply.

Q: Given the current macro environment of zero interest rates and quantitative easing in most advanced economies, can gold serve as an effective hedge against inflation risks and maintain the purchasing power of wealth?

Kass: Gold is a poor hedge against inflation. Adjusting for inflation, gold has returned an average of -0.4% annually since 1980, versus positive annualized returns of 7.9% for U.S. stocks and 6.2% for U.S. bonds.

Q: To what extent have inflation expectations been absorbed by the current gold price?

Kass: Inflation expectations are probably not being absorbed by the current gold price since the Federal Reserve, for example, is projecting inflation at only 2% annually over the next several years.

Q: Should investors devote some space in their portfolios to gold?

Kass: Gold is an alternative asset class that is being used as a speculative store of value. Great investors such as Warren Buffett do not own any gold in their portfolios. If an investor does choose to invest in gold, I would recommend that it comprise a very small percentage of the portfolio, such as 5%.