It’s a well-known axiom that at any given time, the financial market is more or less dominated by one of two emotional extremes: fear or greed. Unsurprisingly, those emotions drive gold investing as well.
For much of the last several months, greed was the dominant emotion in the equity and cryptocurrency markets, both of which saw record inflows from retail and institutional investors (thanks in part to a huge increase in stimulus-driven liquidity).
Nothing lasts forever, though, and fear has once again reared its ugly head due to the untimely return of inflation. In just the last few weeks, rising inflation in the form of soaring prices for certain key commodities has spooked investors into selling inflation-sensitive growth stocks.
Broad market volatility has subsequently increased while investors have run to the relative safety of defensive assets like gold. In this article, I’ll explain why this dramatic sentiment shift should be considered welcome news for precious metals investors in the months ahead.
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In the first half of 2020, fear was unquestionably the dominant emotion for market participants. The pandemic-inspired stock market plunge in last year’s first quarter saw some of the biggest spikes in bearish investor sentiment ever recorded. For obvious reasons, the market was frightened by the unknown threat posed by Covid, not to mention the economic impact of lockdowns and other Covid-related restrictions.
By last summer, however, fear eventually gave way to greed as the world’s leading governments and central banks responded to the threat by unleashing record amounts of stimulus. Financial markets got a huge boost by the sudden onrush of liquidity, and small investors were given a very good reason to rush headlong into risk assets. As the months passed, Covid fears dwindled and greed increased while the liquidity-driven bull market in stocks, cryptocurrencies and real estate gained momentum.
Meanwhile, gold prices—which had rallied during the fear-driven first half of last year—entered a bear market in the second half of 2020. During that time, investors sold their safe-haven holdings in the yellow metal and turned to riskier investments. Without widespread fear to support it, gold investing floundered.
Inflation and Gold Investing
But now that inflation has emerged as a serious threat to the economic recovery, gold has once again revived. Since bottoming in March at $1,680 the price of gold has risen 12% at a time when the tech-heavy Nasdaq Composite Index has shed nearly 8% and hyper-speculative bitcoin has fallen nearly 40%.
Contrary to what many investors believe, it’s not inflation, per se, that’s driving gold investing and boosting prices. It’s true that gold does typically benefit from a persistent increase in inflation over a long period of time (due to its inverse correlation to the U.S. dollar). But more than anything else, it’s the fear of inflation that normally drives gold prices higher.
Indeed, gold’s so-called “fear factor” is often a more powerful catalyst than its currency component. For whenever investors have serious concerns about the future of the economy and the financial market, or geopolitical events, the yellow metal tends to dramatically outperform other major assets. And it so happens that all three of these areas are a concern right now (thanks to inflation, financial market volatility and rising tensions in the Middle East).
Consequently, inflation pressures, combined with continued uncertainties over the state of the global economy and the Mid-East, should provide a solid supporting bid for bullion prices in the coming months.
With fear making such a dramatic return after a long hibernation, I think investors would do well to have some exposure to gold investing—either in physical form or via an exchange-traded fund (ETF)—in order to hedge against further risk asset volatility.
Are you investing in gold given the market’s brief volatility spike and rising inflationary fears?