Gold’s Basic Facts:
- Commodity
- Used as a holder for wealth
- Denominated in US Dollars
- ETF Ticker: GLD (SPDR Gold Trust)
- Beta of ~ 0 with the S&P 500, which means that it moves both up and down with the stock market. This is due to the fact that unlike stocks, gold is not necessarily tied to the actions of the larger market, and thus serves as a solid diversifier to a variety of portfolios.
- In reality, gold is more correlated to REAL INTEREST RATES, which will a strong focus of this article
Macroeconomic Perspective:
With the current economic environment, I believe that gold is in a prime position to perform well. Chief among these factors is the unlimited Quantitative Easing (QE) policy that the Fed has chosen to implement as of this past week. This is significant because it does a couple of things:
- Pushes nominal rates down
- Makes it more likely that inflation will increase (due to the substantial increase in the money supply due to monetization of debt and printing of money)
These are significant because of the connection that the two have with gold. This comes via real interest rates. Real interest rates are equal to nominal interest rates minus inflation. That is the very simplified version, but in principal it still applies. Quantitative Easing includes a 0% interest rate policy from the central bank. This, in turn, affects mortgage and commercial bank rates, as well as bond yields. These should push real interest rates down, especially if inflation picks up.
I believe inflation will be at least slightly on the upside as a result of QE. Earlier this week, the Fed announced their intentions to ramp up their actions by purchasing an even larger sum of government and mortgage-backed securities. Previously, they had committed to monetizing $500 billion(!) in U.S. Treasuries and $200(!) billion in mortgage-backed securities over the next several months. The QE infinity that is about to ensue may make those numbers look like nothing. The Fed will also be buying CORPORATE bonds for the first time in history. All this will go a long ways to increasing the money supply, and if output is unable to match these increases, then higher inflation is on the table. I do not believe that anything like hyperinflation is on the table, but I am expecting some rise in inflation.
Ultimately, this is to say that as asset classes, such as 10 year treasuries, produce low or negative real returns, then it makes sense for investors to store their capital elsewhere, and that includes gold. For reference, real yields on the 10 Year Treasury stood at 0.17 on Friday March 20th, and a week later and after the announcement, they fell to -0.22 on Friday the 27th (Reference: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield).
How has it played out in the market so far?
While there was an initial drop in gold, you have already begun to see people flock to the precious metal (https://www.wsj.com/articles/coronavirus-sparks-a-global-gold-rush-11585332624). This initial drop in gold is largely due to the known fact that in times of severe crisis, all asset correlations approach 1, and this is because investors even have to sell their gold in order to cover their margin calls. However, and as the WSJ reports, various large institutions have made sure to secure their gold.
What are others saying?
- Goldman Sachs came out and doubled down on their bullish take on gold (https://www.marketwatch.com/story/goldman-sachs-says-it-is-time-to-buy-gold-the-currency-of-last-resort-2020-03-24).
A Word of Caution:
The performance of gold, as I have tried to emphasize, relies on how real interest rates perform. My view is that they will drop for the foreseeable future, and that is why I would be bullish on gold. Nominal rates will play their part, as the Fed and its QE Infinity will see to that, yet inflation is more of the wild card. There is a possibility that lower commodity and oil prices, as well as a weakening economy could actually create a deflationary pressure. If this is severe enough, then real rates will behave differently than what I expect.
Last note:
This is my personal take, and this does not serve as investment advice. I publish these to organize and share my own thoughts, and are not intended to be used as investment advice.
For further reading, check out these sources. They really helped me a lot! Also check out Ray Dalio’s LinkedIn post regarding Paradigm Shifts. It’s vital to understand that what has worked in the past, especially in the near past does not guarantee future success (actually far from it).
https://www.kitco.com/commentaries/2019-10-07/Gold-it-s-all-about-real-rates-not-the-dollar.html
