The turmoil in the banking sector commenced in early March. Between March 9, and March 15, the banking sector was at its lowest point. Silicon Valley then Signature Bank collapsed and fragilized the U.S. financial system. On the other hand, the price of gold dramatically increased while the banking system was being destabilized. Gold has always been used as a hedge against inflation, as investors tend to flee from fiat currencies towards the yellow metal. As a tradable commodity, gold is denominated in U.S. dollars, which creates an inverse relationship with the greenback. Thus, when the U.S. dollar rises against other currencies, gold becomes more expensive, which hurts demand. When the U.S. dollar falls, this boosts gold’s price as the metal becomes cheaper for overseas buyers. The price of other investments has an effect on the price of gold. Indeed, when expected or actual returns on bonds, equities, and real estate fall, the interest in gold investing can increase, driving up its price. This is what we’ve been witnessing over the last thirty days.
Source: Bullion Vault
A little after March 6, the price of gold was as low as $1,820 an ounce. This was the exact period when the banking system started to experience financial turmoil. By April 4th, the price of gold reached $2,020 an ounce. This was a $200 or 10% increase in the price of gold. With gold trading 9.5% higher from five weeks ago while silver has jumped by 18.5%, it was expected that the U.S. job data would surely impact the price of gold and precious metal in general. The price of gold surged dramatically for two reasons. First, the bank turmoil made investors nervous about the American financial system. As a means to protect themselves, investors believed that it was necessary to invest in gold, as the value of the dollar would continue to depreciate due to a weak financial system. Tina Teng, from financial services company CMC Markets, said:
“A sooner Fed pivot on rate will likely cause another gold price surge due to a potential further decline in the U.S. dollar and bond yields.”
The hike in interest rates on March 22, confirmed Mrs. Teng’s assertion about gold price. Higher interest rates incentivized investors to purchase more gold, which logically increased its price as demand augmented. Second, investors’ faith in gold as the fundamental commodity that maintains a currency’s value. Although the U.S. Dollar is no longer backed by gold, people still believe in gold because the value of gold ultimately stems from a social construction, based on the agreement that gold has been valuable in the past and will remain valuable in the future. It is, nevertheless, important to emphasize that the price of gold is often volatile over the short term. And this volatility is based on its denomination to the U.S. Dollar.
Is gold a safe investment? This question comes very often when people new to the world of investing seek to diversify their investments. Gold adds, indeed, an important layer of diversification to an investment portfolio because it has shown a negative historical correlation with other asset classes. Thus gold is considered a safe investment to have in one’s portfolio as it remains useful to hedge against inflation.
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