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Don’t fall for the buy gold narrative

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The gold price has risen from less than $1,500 a troy ounce earlier this year, and less than $1,300 last summer, to $1,641.

Then again, in the aftermath of the 2008 crash it briefly rose over $2,000.

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Some rises in the gold price may be logical. After all, after adjusting for inflation, it’s been much higher in the past. But I think that claims that gold is set to soar again are mistaken.

Lesson of history

To explain, consider the last major rally in the gold price. In the build-up to the 2008 crash, the gold price had been steadily rising. There was more than one reason for this. Earlier this century, the gold price was quite low. With gold so cheap, and with the metal having multiple applications from jewellery to electronics, demand rose and with it price.

Another driver then came into play. Increasing uncertainty led to many investors buying into gold as a place of safety.

Inflation fears

If gold rises in price because its seen as place of safety, then this inevitably means it will fall once conditions become less uncertain.

But after the 2008 crash a mistaken view emerged that policies adopted by central banks such as ultra-low interest rates and quantitative easing meant runaway inflation was inevitable. Many pundits argued that gold was consequently set to rise much further as a safe refuge against inflation.

They were wrong. Post-2008, the economy suffered from a chronic shortage of demand, so the risk of significant inflation was always slim.

Gold price today

We are in uncertain times. That in itself is a good reason for temporary rises in the gold price. But I am also seeing a re-run of the same kind of arguments and claims that impending inflation will make gold rise much further in price.

I don’t see it. Inflation occurs when demand is consistently greater than supply. Recent government stimuluses will support demand during this difficult period, but I think it is highly unlikely demand will be boosted excessively.

What are we going to spend money on? We can’t go out. We can’t go shopping other than for essentials. The supply of essentials is easily enough to sustain us, any shortages are due to panic buying, which will be short lived.

I believe that for a year or two after the crisis, the economy will be performing well below capacity. In such conditions, inflation is highly unlikely.

Without government stimulus planned for the next year or so we would be on the verge of experiencing a deep economic depression. The stimulus should be enough to avoid this and create a reasonably quick return to normal. But these are hardly the conditions that rapidly rising inflation is made from.

The gold price may rise a little further, or it may not. But I doubt it will rise to the giddy heights some are predicting.

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Views expressed in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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