One beneficiary of this uncertainty has been gold. It has risen almost 20 per cent in US dollar terms since late 2015, and of course much more in sterling terms.
You might think this is obvious. Gold should be a safe haven and so it should do well in times of uncertainty.
Here, then, is a surprise. It's only in recent years that political uncertainty has been positively correlated with the gold price. Before the financial crisis, the correlation between the two was negative. It's only since then that uncertainty has been good for gold.
There are two reasons for this. One is that for much of the early 2000s policy uncertainty was so low that investors mostly ignored it.
The other is that since the crisis there's been a strong link between uncertainty and real bond yields, as measured by longer-dated index-linked gilt yields. In recent years, policy uncertainty has been associated with lower real yields but this wasn't the case before 2007. This means uncertainty has given a double boost to gold. It's increased gold prices directly, through a safe-haven effect. And it's increased them indirectly via lower bond yields, because lower yields are associated with increased demand for gold. (One reason for this is that lower yields on financial assets reduce the opportunity cost of holding gold and so raise demand for it.)
| Correlation with gold | ||
|---|---|---|
| Jan 97-July 2007 | Since August 2007 | |
| $ trade-weighted index | -0.80 | -0.30 |
| Oil price | 0.90 | 0.44 |
| Global policy uncertainty | -0.39 | 0.32 |
| Vix index | -0.65 | -0.38 |
| Break-even inflation | 0.39 | -0.67 |
| Index-linked gilt yield | -0.59 | -0.36 |
| 10-year gilt yield | -0.27 | -0.83 |
| Monthly data, gold is in $ terms |
It's not just the link between gold and uncertainty that's flipped over since the crisis, however. So too has that between gold and inflation expectations, as measured by the UK break-even inflation rate. Before 2007, the correlation was positive: higher inflation expectations (or inflation risk) were accompanied by a higher gold price, as you might expect. Since then, however, the correlation has been negative: it has been falling inflation expectations, not rising ones, that have raised gold prices.
There's a reason for this. Since 2007, break-even inflation has been a cyclical indicator. It plummeted in 2008-09 as investors feared recession and deflation, and fell again during the 2012 euro crisis. These fears increased safe-haven demand for gold. And as the fears receded (especially in 2013) that safe-haven demand fell and with it the gold price.
The point here is simple. Relationships between the gold price and economic fundamentals are unstable. Yes, higher oil prices, lower interest rates and a weaker dollar seem to have been consistently good for gold. But other factors such as uncertainty and inflation expectations have had an unstable relationship with the metal. And if relationships can change once, they can change again. As former Federal Reserve chairman Ben Bernanke said in 2013: "Nobody really understands gold prices and I don't pretend to understand them either."
I don't think this is an argument against holding gold - although it is a reason not to trust forecasts of where its price is heading. Gold's virtue is as a portfolio diversifier; in particular, it has only a weak correlation with equities. The fact that its price moves in strange ways does not undermine this virtue.
