Gold vs. Economic Crisis: A Safe Haven? (Part 2)

Introduction

In the previous article, we examined five economic crises from 1982 to 2020 and how gold prices changed during those periods. This time, we will review the 1970s, often referred to as the inflation era. Afterward, I will show the relationship between the U.S. dollar and gold prices before concluding.

The 1970s: The Era of Inflation

The 1970s is often called the era of inflation. Although the two oil shocks in 1973 and 1979 delivered decisive blows, the U.S. had already begun losing control over inflation prior to these events. On August 15, 1971, President Nixon announced the suspension of the dollar's convertibility to gold, followed by domestic price controls and additional tariffs on imports. The prolonged Vietnam War had resulted in excessive fiscal deficits, and the worsening balance of payments meant that the U.S. could no longer sustain gold convertibility. Up until then, the price of gold had been fixed at $35 per ounce, and foreign currencies were pegged to the U.S. dollar. However, the suspension of gold convertibility marked the end of the Bretton Woods system established after World War II, ushering in the era of floating exchange rates.

The first oil shock occurred two years later. In 1973, the Yom Kippur War triggered the first oil shock, and in 1979, the Iranian Revolution, followed by the Iran-Iraq War in 1980, sparked the second oil shock. As a result, oil prices skyrocketed, and U.S. inflation surged to around 15%.

Source: www.macrotrends.net

With that background, we can better understand the changes in gold prices. Looking at the chart above, between January 1971 and January 1980, gold prices surged by 1,690%, translating to an annual return of 37.8%. Over this period, gold rose by an average of 37.8% per year. During the same period, the DJIA rose by just 1% (not per year but for 9 years). Given that the average U.S. inflation rate during the 1970s was around 7.1%, investors suffered a massive loss in real wealth by investing in the DJIA. In contrast, gold delivered an impressive annual return of 30.7%, even after accounting for inflation. During the 1970s, gold was less of a safe asset and more akin to a long-term high-growth stock.

However, the idea of buying gold in early 1971 and holding it for nine years to multiply your money 18 times was far more difficult than it sounds. Let’s zoom in on the period from November 1974 to August 1976.

Source: www.macrotrends.net

During this time, while the DJIA surged by 57% in just nine months, gold prices plummeted by 40%. This was between the two oil shocks, a period when inflation dropped below 6%, leading to relative price stability. Afterward, inflation surged again, gold rebounded and began its historic rise, while the Dow Jones re-entered a prolonged period of weak returns. While we know the outcome today, investors at the time, faced with two years of falling gold prices and rising stocks, would have found it difficult to resist the temptation to sell gold and switch to soaring equities.

As a side note, the U.S. banned private ownership of gold during the Great Depression in 1933. The government was serious, with violations punishable by a fine of up to $10,000 (more than $200,000 in today’s dollars), up to ten years in prison, or both. Individuals were only allowed to own gold again in 1974.

Before concluding, let me present one more chart.

Relationship between the U.S. Dollar and Gold

Source: www.macrotrends.net

The chart above shows the relationship between the U.S. dollar and gold prices over the past decade. The blue line represents the dollar index, and the red line represents gold prices. Over the past ten years, both have generally trended upward. However, the key takeaway is that, typically, when the dollar strengthens, gold prices fall, and when the dollar weakens, gold prices rise. This generalization didn’t hold from late 2023 to mid-August 2024, when both the dollar and gold prices rose together. However, by September 2024, gold prices continued to rise, breaking records repeatedly, while the U.S. dollar started to fall, and the inverse relationship resumed.

Conclusion

We've now reviewed six economic crises: (1) the 2020 COVID-19 pandemic, (2) the 2008 global financial crisis, (3) the 2001 dot-com bubble burst, (4) the 1997-98 Asian financial crisis, (5) the 1982 Latin American debt crisis, and (5) the 1970s inflation crisis. Except for one instance (the Asian financial crisis), gold prices rose significantly during these crises. The exception saw gold prices drop by about 12% from their peak, possibly due to gold collection campaigns in Asian countries as part of efforts to overcome the foreign currency crisis. However, with a 5:1 winning ratio, gold remains a favorable bet for investors concerned about the possibility of economic or financial crises. It may be wise for such investors to hold a certain percentage of gold in their portfolios, even if they believe the likelihood of a crisis is low.

Thanks for reading. Wish you grow rich slowly and surely!

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