Look Who's Buying Gold

"The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures." - Warren Buffett Fortune Magazine, 1977*

Fool's Gold? Gold has confounded investors this year. Though widely considered an inflation hedge, gold is down ~7% since January when inflation began heating up. How can this be? Does it mean that gold isn’t really an inflation hedge? The answer is that it depends. Look Who’s Buying Individual investors have given up on gold as a hedge this year. During the third quarter, ETF investors sold a significant amount of their gold holdings. Gold investment was down 47% year-over-year (in tonnes excluding OTC). But guess who was buying? Central banks bought a record amount of gold during the third quarter, far ahead of purchases during prior years’ third quarters.

This buying was led by central banks in emerging markets. Goldman Sachs in a recent note** argues this is the beginning of an inflection point of a long-term trend. Following the Cold War's end in the 1990's, geopolitical tensions moderated and markets gained greater confidence in central bankers’ ability to maintain inflation stability. Over the following decades, central banks proceeded to sell gold and buy dollars for their reserve assets, thus denting gold demand. This year’s surge in central banks' gold buying may signal a reversal of this post-Cold War monetary order, according to Goldman.

Is Gold a Hedge?

Traditionally gold has been viewed as an inflation hedge. An important nuance, however, is that gold is a vote of confidence in a central bank's ability to maintain the value of its paper money. During high inflations when this confidence is low (as during Burns tenure running the Fed in the 1970's), gold is viewed as a hedge. During inflations where confidence in central bankers is high (as during Volcker’s tenure in the 1980's), gold is not a good inflation hedge.

Think of gold today as a vote of confidence in Fed Chairman Powell’s ability to get this inflation under control. Investors are taking his tough talk seriously, hence the stagnation in gold's price. What is ultimately more relevant for us is how dedicated the Fed is to maintaining the dollar's purchasing power in the decade ahead.

Actions speak louder than words. And long-term actions speak louder than short-term actions. The Fed has doubled the money supply in the past ten years, yet let it decline ~1% thus far this year. (So that's one hundred steps forward, one step back.) Meanwhile, other central banks are buying gold.

Fun Fact

There’s a reason gold is called a precious metal. It is rare. All the gold ever mined from the earth would not fill the Washington Monument. Ironically, central bankers are the opposite of precious. It would take the equivalent of four Willis Towers to house the 73,800 employees working in central banks in the US, Europe, and Japan.***

Though we jest with this silly comparison, it does create a powerful image of how precious this metal really is. We continue to believe that gold will serve as a better store of value than paper money over time.

Yours in the Field,

Frank Byrd, CFA Steve Korn, CFA

*"How Inflation Swindles the Equity Investor" by Warren Buffett. Fortune, May 1977.

**Goldman Sachs Commodities Research, Mikhail Sprogis and Sabine Schels, “Gold: The Fed vs EM Central Banks”, Nov 7, 2022.

***Sources: “Are there too many central bankers?”, The Economist, Feb 24, 2020; and Fielder Capital's calculations.

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