A Hazy Shade of '68*

When we come across unprecedented challenges such as the year 2020 has thrown at us, we, observers of the markets, love—or are guilty of—looking back in history to find similar periods for comparison. When the pandemic started earlier this year, 1919—the year of the Spanish flu—was mentioned quite a bit. Then it was the turn of 1929 when markets cracked in mid-March. But to me the most apt comparison is 1968.

The 1960s was a period of low volatility, benign inflation, and good economic growth, but underneath it all, a lot of social issues were coming to a breaking point. The civil rights movement was gaining ground; America’s involvement in Vietnam was increasing by the day amid Cold War concerns; and from capitalist New York to communist Prague, the younger generations were challenging the status quo. Then came 1968 —“the year that rocked the world” as author Mark Kurlansky called it in his eponymous 2004 book—when protest movements erupted simultaneously around the world. Before the spring of that year, any social observer would have been forgiven for thinking that 1968 would be no different from the preceding years, despite its being an election year when President Johnson was considered a favorite to win a second term.

There was one area, however, where the established postwar order was already being challenged. The monetary system after World War II was a more flexible gold standard where the dollar was pegged to gold at USD 35 an ounce, and other currencies were fixed to the dollar. The first crack in the system was the 1967 devaluation of the British pound, which to many observers at the time was specific to the UK, but was to become a harbinger for bigger things to come globally.

In the US—already the anchor of the world monetary system—the late 60s was a period of ballooning current account and budget deficits, not least due to the Vietnam War. Between 1967 and 1968, the US lost 10% of its gold reserves as investors and some central banks started to convert their dollars into gold. The Johnson administration tried to bring both deficits into balance by announcing belt-tightening policies including a plan to keep Americans from traveling abroad. These proposals fell short of calming the gold market, and by early March of 1968 gold trading had been suspended in London, with prices in the smaller Paris market surging to USD 44 per ounce. Because Americans were not allowed to hold and trade gold, silver prices went up significantly.

This rising interest in precious metals today is another similarity we have with 1968—the gold price last week crossed USD 2,000 per ounce for the first time. And if we really are in a similar situation to 1968, then we might be in for a ride, as the 1970s was a decade to forget for many investors. But let’s not get too ahead of ourselves, because while the similarities were many, so were the differences.

For one, inflation was much higher in the late 60s compared to today, as the strong disinflationary forces of our time—including worsening demographics and the globalization of manufacturing—were absent back then. We are also hopeful that the fight against COVID-19, which is stretching our fiscal levers, will be a much shorter one compared to the Vietnam War.

If we go back to the late 60s to look at what happened to gold next, the price of the yellow metal was stabilized by an intricate two-tier system that worked until the early 70s, when the gold standard was abandoned. Because the gold price had been capped for decades, its sudden liberation unleashed a demand that caused a spike in price over the following years. Today, because gold has been trading freely for several decades, that type of pent-up demand is not there.

Another difference: Gold kept rising in the 70s as the world economy entered a stagflationary period largely due to the oil embargo. Today, the world economy is a lot more energy efficient, and innovations have allowed the US to be energy independent. Finally, we are confident that policymakers are guided by the lessons learned from the mistakes of the late 1970s. In 2008, we could have gone into a depression similar to the 1930s, but our policymakers steered the economy out of a crash of that magnitude. There is reason to be optimistic.

This does not mean that the rise of gold has been unwarranted. Interest rates will be low for a long time while governments will keep on spending more. This has pushed bond yields lower and inflation expectations higher, resulting in very negative real rates. There is also the fear that the United States will follow other developed countries into negative rate territory, which would make gold look a lot more attractive versus fiat currencies from an opportunity cost point of view. Also, if the dollar has peaked, commodity prices including gold should rise further. We expect gold prices will be supported by these trends, but we don’t think a return to the 1970s is necessarily in order. However, a small allocation to gold in portfolios would be prudent.

The analogy of our time to 1968 and the 1970s is one we will be following closely, but let’s remember that in addition to these differences, it was not all gloom and doom back then. Women made great strides in society; music and movies from the 70s are still cherished today; and some of the most iconic companies now such as Apple and Microsoft were born during that decade. So while we may now be seeing hazy shades of a volatile past, the decade ahead might also be a shinier one for gold investors.

*With apologies to Simon and Garfunkel

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