Understanding the Recent Gold Rally and Currency Value Concerns

Gold prices have jumped more than 60% this year, climbing above $4,300 per ounce. This sharp increase has made headlines and left many investors wondering whether this rally is unique compared to previous ones.

Some people call this the “debasement trade.” This term comes from the concern that governments might weaken their currencies by spending more than they collect in taxes and by keeping interest rates low. Combined with a weaker U.S. dollar, these worries have led some investors to prefer assets like gold, which are seen as holding their value over time. This preference has grown as stock market swings have increased.

While concerns about government debt levels are real, past experience shows that predicting gold prices is hard. Also, the recent market gains are driven by more than just currency values and interest rates. For investors focused on the long term, the key question isn’t whether to choose between stocks and bonds versus gold. Instead, it’s about finding the right mix of different investments in a balanced portfolio.

Most importantly, it’s essential to understand the difference between short-term trading and long-term financial goals like generating income and growing wealth, especially after an investment has already seen big gains.

A look back at currency debasement through history

The idea of currency debasement goes back thousands of years, though it tends to come up again every few years. Traditionally, “debasement” meant that governments reduced the amount of precious metal in coins. This let governments make more coins from the same amount of metal, but it also meant each coin was worth less.

Today, most currencies are called “fiat currencies.” This means their value comes from trust in the government that issues them, not from being backed by gold or other precious metals. Modern debasement concerns focus on whether governments will allow higher price increases (inflation) and a weaker currency. A weaker currency would make it easier for governments to manage their existing debts.

This connects to ideas that became popular after the 2008 financial crisis. Economists Reinhart and Rogoff described “financial repression” – policies that keep interest rates artificially low to reduce what governments pay on their debt. This hurts savers because the value of their cash falls when interest rates don’t keep up with rising prices. With government debt continuing to grow, it makes sense that some investors worry about these policies and want to own assets that hold their value.

However, the evidence about whether this is happening today is mixed. First, inflation rates have been stubborn but not extreme. The Consumer Price Index (which measures what consumers pay for goods and services), the Personal Consumption Expenditures Index, and the Producer Price Index (which measures what producers pay) are all at 3% or lower. Second, the bond market isn’t expecting high inflation either. The 10-year Treasury yield (the interest rate on government bonds) has recently fallen to 4% or less. Treasury Inflation-Protected Securities (TIPS), which are bonds designed to protect against inflation, suggest investors expect only 2.3% inflation.

Two other points are worth noting. First, central banks (the institutions that manage countries’ money supplies) worldwide have been buying gold to strengthen their reserves. This has increased due to global uncertainty and the weakening dollar. Second, while the dollar’s value has dropped about 10% this year, it remains near the high end of its range over the past twenty years. In other words, looking at the bigger picture, the dollar is still quite strong compared to its historical value.

Predicting gold rallies is challenging

As an investment that can swing dramatically in price, gold naturally attracts investor attention. Over recent decades, gold has seen dramatic price increases with varying outcomes. In the late 1970s, gold surged as investors worried about high inflation combined with slow economic growth, and about the Federal Reserve’s independence. Gold peaked above $800 in 1980 – a price it wouldn’t reach again until 2007.

A similar pattern happened after the 2008 financial crisis when central banks added large amounts of money to the financial system. Many investors reasonably worried about runaway inflation and a collapsing dollar, but neither happened. Gold doubled from 2009 to 2011, reaching about $1,900 per ounce, then fell back toward $1,000 over the following years. This happened even though the Federal Reserve didn’t start reducing its support measures until 2013 or raise interest rates from near zero until 2015.

The accompanying chart compares gold’s performance to the S&P 500 (a stock market index) since the market peak in 2007. While gold has had periods of strong performance that provide diversification benefits (meaning it moves differently than stocks), the S&P 500 has still performed better over the full period. For investors watching daily stock market movements, this might be surprising. Again, this highlights why it’s important to view all investments as part of a complete portfolio.

Multiple types of investments have contributed to portfolio gains this year

The current gold rally, which started in 2024, has happened alongside strong performance across many investments. This includes artificial intelligence stocks like the Magnificent 7, international stocks, bonds, and cryptocurrencies. The accompanying chart shows that many different types of investments have contributed to portfolio returns this year. While gold has certainly done well, there will always be individual stocks and other investments that perform well in any given year.

For many investors, gold plays a role as part of a broader allocation to commodities (raw materials and agricultural products). The Bloomberg Commodity Index, for example, started the year with a 14.3% allocation to gold. Along with other commodities like silver, industrial metals, energy, and grains, this index has gained 10.6% year-to-date.

There are other reasons to hold many different types of investments aligned with long-term financial goals. One important consideration is that gold generates no income, unlike bonds or dividend-paying stocks (which pay regular cash distributions to shareholders). So, a portfolio too heavily weighted toward gold gives up the longer-term growth potential of stocks and the income from bonds.

The bottom line? Some investors are worried about the weakening value of the dollar, especially as gold prices continue to rise. Investors should view gold as one part of a broader portfolio that aligns with their long-term financial goals.