History suggests gold has yet to peak, inflation could drive the next leg up

NEW YORK (November 5) Gold is in the midst of its third major bull run since 1971, and the others also saw major pullbacks, but government debt, geopolitics, the dollar and inflation will likely push prices higher during the current cycle, according to Russ Mould, investment director at AJ Bell.

“Gold is up by 45% in dollar terms over the past twelve months, a gain that makes the Nikkei 225, NASDAQ Composite and Hang Seng indices look like slouches and also one that prompts the question of just how high the metal’s price can go before it starts to look bubbly,” he wrote in a recent analysis. “Sceptics who still view gold as a barbarous relic, a useless lump with no yield or even an asset that currently has a cost of ownership of 4% thanks to lost interest on cash will all be nodding as the metal slips back from last month’s new peak, but this slide may not mean its surge is over. Both of the 1971-1980 and 2001-10 bull runs featured several retreats which did not ultimately nullify or prevent major gains.”

The first bull run Mould looks at began when President Nixon withdrew from the gold standard and scrapped the Bretton Woods monetary system. “As Nixon began to run up the US federal deficit, and inflation surged, not helped by two oil price shocks, gold motored from $35 an ounce in August 1971 and peaked at $835 in January 1980,” he noted.

And while gold investors were protected from severe inflation, the ride was not a smooth one. “Even that gilded run in the 1970s featured no fewer than three mini bear markets, where gold fell by more than 20%, in 1973, 1974 and one that lasted more than eighteen months from January 1975 to summer 1976. To further test bulls’ mettle, gold also endured five corrections where its price fell by between 10% and 20%, in 1972, 1973, 1977, 1978 and 1979.”

Mould said that while the final two lasted only a month, “they still challenged the resolve of gold bugs even as its price went almost vertical in the final blow-off phase of the bull run.”

“Gold then went into hibernation as the Paul Volcker-led US Federal Reserve, and the UK’s Thatcher administration, took it upon themselves to crush inflation, helped along the way by deregulatory policies on both sides of the Atlantic, a return to peace in the Middle East and lower oil prices,” he wrote. “Double-digit interest rates also made the opportunity cost of owning gold simply too great to bear.”

But after bottoming out just above $250 per ounce in 2001, gold attracted “a new generation of investors, who sought refuge from the ultra-loose monetary policies which followed the bursting of the technology, media and telecoms bubble in 2001-03 and then the Great Financial Crisis of 2007-09,” Mould said. “In the face of zero-interest-rate policies (ZIRP), Quantitative Easing (QE) and balance sheet expansion the hunt was on for stores of value or haven assets, and some investors felt that gold was a good candidate.”

“Even during this second surge, gold did its best to test the resolve of believers with a pair of bear markets, one in 2006 and one in 2008, while there were also five corrections of more than 10%, one in each of 2003, 2004, 2006, 2009 and 2010,” he pointed out.

The yellow metal peaked just under $1,900 per ounce in 2011 before sliding down to $1,000 by 2015 as central banks reasserted control after the Great Financial Crisis. “Mario Draghi’s 2012 promise to do whatever it took to preserve the Eurozone edifice was also seen as a warning shot and a period of low growth and low inflation persuaded many that calm had returned, and gold’s services were not required, especially as the EU debt crisis seemed to blow over,” he said.

But after 2015, gold began to make stealthy gains, “long before Covid-19, lockdowns, soaring government support payments came along, let alone tariffs and trade wars, fresh unrest in the Middle East and a war in Eastern Europe,” Mould noted. “Perhaps gold’s message was that central banks would find it hard, if not impossible, to extricate themselves from ZIRP and QE, and that their balance sheets would remain swollen – a view that the Fed’s halt to Quantitative Tightening (QT) this autumn would suggest is still relevant to this day.”

He noted that this third multi-year bull market rally also had bearish stretches and significant corrections.

“A swoon of more than 20% caught some bulls off guard in 2022, as the world emerged from lockdowns and 10%-plus corrections in each of 2016, 2018, 2020, 2021 and 2023 warned that volatility was never far away.”

Mould said all of this is very relevant to the current rally – and to the economic and financial challenges of the present day.

“Galloping government debts, and interest bills, lead gold bugs to argue that ZIRP and QE could yet come out of the central bank toolbox, especially as some central banks now seem less willing to own US Treasuries and US dollar assets than before, either for political or economic or financial reasons,” he wrote. “If growing debt, sticky inflation, war and political and fiscal policy pressure on central banks and the monetary authorities are all perhaps playing a role in gold’s latest rise, then it seems reasonable to assume that investors will wait for at least some of those threats to fade before they look to move away from gold once more – as they surely will one day.”

“In the meantime, one possible guide as to whether the metal is nearing a peak for this cycle or not is how affordable it is,” Mould said. “One way of judging this is to look at how much metal a household can buy, if it maxes out its earnings. If bullion moves beyond the reach of the average worker, or, dare one say it, private investor, that could at least crimp one source of incremental buying.”

“Before US President Nixon took America off the Gold Standard and smashed up the Bretton Woods monetary system in August 1971, an ounce of gold represented barely 1% of the average US household’s annual disposable income,” he noted. “That figure peaked above 9% in late 1980 at the end of the great 1970s bull market in gold.”

“In this context, the current percentage of nearly 6.5% suggests gold could yet go higher, especially if inflation starts to pick up and drag earnings with it, either by means of pay increases or asset price gains.”

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