Rising gold prices – it’s the interest rates, stupid!
Nothing gets investors as riled up as gold – love it or hate it, everyone has an opinion about the yellow metal. Very often, the story you hear about gold in the media is news cycle driven. When there is some kind of important geopolitical event – say, the tension in the Ukraine – then news organisations everywhere will duly note the rising gold price and attribute it to gold's safe haven status.
What makes this interview so interesting, then, is that Paul Walker thinks this type of narrative is, to put it politely, bunkum. For Walker, the gold price is the result of certain fundamental drivers – interest rates, monetary policy, the outlook for returns on other asset classes and suchlike – rather than day-to-day events and upheavals. Seen from this vantage point, the story of gold over the last few weeks looks quite different. What we seen, instead of gold reacting to political tensions, is gold as an indicator of broad market expectations, specifically, the expectation that stocks in the US, Europe, and emerging markets are going to struggle to deliver strong returns this year. – FD
ALEC HOGG: Tensions between Russia and the West over Ukraine, and worries over an economic slowdown in China has caused gold to move to a six-month high. The Gold price is up over three percent in the last little while, as safe-haven demand continued to attract more investors back to the market. Well, the man who knows more about gold than anybody I believe, on earth, is Paul Walker. He is now CEO of Isondo Precious Metals – previously from GFMS. Paul, you're out on your own again and living in Cape Town.
PAUL WALKER: I'm loving it.
ALEC HOGG: It's great for us to have you back in the country after all these travels around the world. Gold though, is still an area where you're paying a lot of attention, no doubt.
PAUL WALKER: Indeed.
ALEC HOGG: Take us through what is going on with the gold price at the moment. The obvious thing of course, is that tensions in Ukraine mean that the risk of serious confrontation has risen, but is that the only thing.
PAUL WALKER: Alec, you and I have spoken about this over the years and I've always been somewhat sceptical about the impact of these geopolitical events on gold…certainly, on the long-term impact on the gold price. If you look at the noise in the current levels of the gold price, undoubtedly the Ukrainian crisis has a small explanatory component to it. I think the really underlying theme that's still driving the gold price is the one you and I have discussed for many years. It's about interest rates. It's obviously how this ties into the strength and weakness of the Dollar. If you look at what the Dollar's been doing over the last couple of weeks, it's weakened markedly for reasons that I find somewhat inexplicable, given that the fundamental case for the U.S. economy is probably much stronger than the Euro Zone. It is however, about interest rates. The core underlying story for everything you see happening in gold in my opinion, really comes down to interest rates, and how those interest rates manifest themselves in various asset classes. Gold, interest rates, the Dollar…where we see the Dollar today is far more important in understanding why gold is where it is at the moment, and where it's going to go over the next six to 12 months.
ALEC HOGG: But that's all…I won't say 'old news', but that's all in the market. In December, the gold price was $1200.00 per ounce. Now, it's nearly $1400.00 per ounce. Would that $200.00 uplift then be tension-related, Ukraine-related, or is it even less?
PAUL WALKER: I really don't think it is. I think it is fundamentally about interest rates and what the Dollar's been doing. If you look at the Dollar today, I think it's probably trading at round about 139 or something. It's very much a backdrop to why gold is performing the way it is. The thing about interest rates that you have to bear in mind: if we're in a situation where the markets expect interest rates to stay at low levels for much longer periods of time, investors will start to look at asset classes that show some capital gain – some return that they won't get from putting their money in the bank. I think the story now, in the market – one that most people are fairly comfortable with – is that interest rates are going to stay low for a considerable period. U.S. interest rates: with Yellen on board, we're not going to see a sudden spike in interest rates; at the short end, definitely not and even at the longer curve, it's not going to happen. People have therefore come back in search of yield, and as you say, in a sense, it's an old story – the story of gold over the last 10/12 years. It's about a search for yield in capital appreciation. Gold has been a very good vehicle for people to get returns through capital appreciation. My view is that what we're seeing at the moment – the recovery in the gold price – is very much the market speaking with a single voice and saying 'we think interest rates are going to stay low for a considerable period of time. Yellen's not going to shock us with rising interest rates'. If you cast your mind back to when gold did come under significant pressure at the tail end of last year, I think that was on the expectations that interest rates were going to move. It hasn't happened in the way it was anticipated, and gold has come back. It's a search for yield.
ALEC HOGG: Is there an 'inflation play' there somewhere, Paul? If you keep stimulating the money supply for long enough, it has to surely, have some kind of inflationary impact. For years, gold bugs have said that's part of their play.
PAUL WALKER: I've never bought this argument, Alec. Again, you and I have discussed this on air before. If you have a look at the contemporary performance of gold in an inflationary environment, it hasn't done well. Cast your mind back to the 1980's and the Volker years. What happened there? We had very elevated levels of inflation and gold went down in real terms. I think between 1980 and 1995, the real gold price probably dropped by something like 80/85 percent – the real gold price. Gold has therefore shown itself in a contemporary setting to not be a very good hedge of measured inflation. You'll also remember that we had a discussion quite a few years ago, where I went on my rant of the moment, about the inflation measures typically used globally. I've always made the point that the biggest inflationary pressure that we've seen over the last 15 years has been the inflationary pressure on housing. Of course, most of the statistical offices these days find ways of excluding housing. I was working at the House of Commons back in the 1990's when the British decided to strip out Housing – why – because it was too volatile an element. I'm saying 'hang on. I spend 50/60 percent of my income on housing. Damned right, I want to see this as part of the inflation measures'. What we've seen over the last 15 years is the manipulation of statistics, or the omission of Housing in this measure. In a sense, gold has been a good hedge of inflation – to get back to the point. If you look at the performance of gold in the 2000's, I would say it was showing very strongly, signals that there were asset-priced misallocations out there. Housing prices were rising, which is an inflationary impact on most normal people who have a mortgage or are looking to buy a house, and gold performed very well. In a similar conventional way, I'd say gold actually did its inflationary hedge throughout the 2000's. In a formal way, if you look at headline levels and inflation, though certainly, in the 1980's and the 1990's gold actually underperformed, so it's not a hedge against inflation in that sense.
ALEC HOGG: Interesting insights. Paul, just before we go, the platinum price is getting a little bit of life. Now, we do have an eight week-old strike in the sector, but talking earlier to Sasha Naryskine, he was quite bullish about fuel cells. Are you seeing that coming into play yet?
PAUL WALKER: Yes, I heard. Well, I have to declare an interest for your viewers Alec, in that I am involved in the fuel cells base. I happen to be very bullish about the prospects…not as much on the automotive applications. I think that stationary fuel cells are actually here. Many of your viewers probably don't realise how many applications now are utilising fuel cells. The Japanese have been at the forefront of this post-Fukushima. From very low levels – admittedly – you've seen very substantial installations going into the Japanese markets. Most importantly, the infrastructure in Japan has evolved to support this. It's hydrogen. You can use methanol. Isando (the company I'm with) – we're looking at direct methanol, but there are a variety of manifestations of use of platinum in fuel cells. I think the real application that's going to change – fundamentally – the supply/demand balances for platinum over the next five to ten years, is going to be in the area of stationary fuel cells. Yes, I'm very bullish, but as I say, I do declare an interest. I'm very involved in this at the moment.