Slowing growth adds to the monetary policy complexity confronting central banks. If central banks can’t raise interest rates enough to tame inflation before triggering a recession,they could face increasing public pressure to reduce interest rates.
This could allow inflation to remain at elevated levels,raising the risk of stagflation:persistently high inflation combined with stagnant demand and rising unemployment. The top-performing assets during periods of stagflation since 1973 have been defensive and real assets,including gold,which has averaged a price gain of around 30 per cent.
With the threat of a recession,investors are confronted with a more complex investment universe and diversification can become more difficult. From the early 2000s until recently,equity and bond prices tended to move in opposite directions. Investors were able to build a diversified portfolio with only these two asset classes – commonly referred to as the 60/40 equity-bond portfolio.
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However,with the breakout of inflation,this correlation has flipped from negative to positive,meaning the 60/40 portfolio is no longer well diversified. Investors need to add other low-correlation asset classes,such as gold,to achieve diversification,so when share markets fall the hit to their portfolios won’t be so hard.
Some of the strongest demand for gold has come from central banks,the most conservative investors of all. Net purchases of gold by central banks in 2022 totalled 1136 tonnes,an increase of 152 per cent on 2021. Not only was 2022 the thirteenth consecutive year of net central bank gold purchases,but also the second-highest level of annual demand on record going back to 1950.
A recent International Monetary Fund (IMF) working paper noted that fear of trade-restricting economic sanctions is pushing nations to diversify away from holding US dollars. It is therefore not surprising that emerging market central banks accounted for the bulk of net gold purchases in 2022.