Low inflation in developed economies have become a curse since the Great financial crisis of 2008. It discourages producers, as inconsiderable rise of prices means low demand and difficulties in sales. Thus, the growth of the economy is also under threat. Developed economies have been struggling for several years to meet the inflation target of two % and yet have hardly succeeded in it.
Many quantitive easing programs and lowering interest rates throughout the globe have been tailored to meet this ultimate goal. Such efforts were made consistently by the U.S. Federal Reserve (Fed), the European Central Bank, the Bank of England, the Bank of Japan, the Bank of Switzerland, the Reserve Bank of Australia, the Reserve Bank of New Zealand and others.
According to the Philips curve economic concept inflation and unemployment have a stable and inverse relationship like connecting vessels. According to this concept in order to lower unemployment, higher price growth should be accepted. So unemployment and the inflation level should be balanced so that the lesser of two evils can be chosen. But in recent years one does not need to be chosen. Any attempt of the central banks to kick the inflation up has had no significant effect so far.
This time the situation turned out to be very interesting as the coronavirus forced worldwide monetary regulators to pump enormous liquidity into the financial system. Thus, the outlook for financial assets perspectives have become very intriguing. The slump of the economy in the United States by 32.9% in the second quarter of 2020 is unprecedented for many decades. Now it is followed by the decline of the inflation from the successful rate of 2.5% in January to a close to deflationary 0.6% in June.
However, the market is behaving as if the inflation has already skyrocketed according to the Philips curve. Stock indexes that are considered risky assets and consist of shares of production and service companies, rebounded almost to the February levels and simply ignored the economy slump by almost a third.
Gold usually moves in counter-cyclically manner compared with stocks due to its safe haven asset nature as it protects investors from inflation or depreciation of currencies. Longstanding low inflation in developed countries since the crisis of 2008, led to a weak demand for gold. Gold prices dived from their peak of $1920 per troy ounce in 2011 to $1450-1500 before the pandemic in the beginning of 2020. Suddenly, amidst the crisis there was a slump of the global economy and almost zero inflation and over the period of a few months, gold delicately soared to over $2000 ignoring historic highs with ease.
There are several reasons for such a paradox. But, the major reason is probably the unprecedented pumping of money into the global economy to save it from COVID-19. The upside synchronous movements of stocks and gold may be explained by the expected future inflation that pushes both risky stocks and safe haven gold.
The annual rise of monetary base (M2 aggregate – cash, checking deposits plus savings deposits, money market securities, mutual funds, and other time deposits) was between two and ten % in 2010-2014 in the United States, according to Morgan Stanley. In 2015-2019 the annual rise of M2 was in between three to seven % despite curtailing QE’s. In 2020 the M2 aggregate surged to 23%. The pace and the speed of the monetary supply now is totally different from what it was before a decade ago. The Fed’s facilities to inject money into the American economy are poles apart from previous moves to bolster inflation. The U.S. Treasury has also joined the Fed to unite efforts in order to provide extra “helicopter money” to some people who did not benefit previously. More money is expected to be released through another stimulus program worth at least one trillion Dollars.
Considering all this, another rally in stocks and gold prices may be possible. And this rally may continue despite the fact that the demand for physical gold for the industry is declining. The industrial consumption of gold fell by 18% in the second quarter of 2020 compared to the same period of the previous year. The jewelry industry’s consumed gold fell by 53% from where it stood a year before. Even the central banks reduced their purchases of gold. Gold prices instead rose by 30% since the beginning of 2020, and this might not be the end of the climbing.
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