May 19, 2022
  • May 19, 2022

A Sober Look at Gold (NYSEARCA:GLD)

By on April 18, 2022 0

marsmeena29/iStock via Getty Images

Following the market narrative around gold has been a foolish game. On the one hand, there are the narratives that gold is inversely related to real interest rates and since the latter are expected to rise, gold is therefore a poor and risky market. investment. There are also stories such as that gold is a hedge against inflation and geopolitical risks and as such should closely monitor the latest news in these areas or such that gold is expected to skyrocket to $5000 on the back of so-called “money printing”.

As an investor exposed to the precious metal, not falling victim to these narratives was the most sensible course of action. However, it should be kept in mind that these accounts are partially true and as such are not entirely irrelevant to the gold exposure thesis.

Hold gold, without being a gold bug

Before continuing, I must clarify that I do not like to hold gold.

One thing I am good at is valuing companies, their intangible assets and evaluating their strategy, management and competitive advantages. In doing so, I sift through the weakest companies and allocate my capital to those that I believe are the best.

As a result, these companies stand a good chance of creating not only shareholder value, but also value for their customers and society as a whole. On the contrary, holding a glowing pet stone locked away in a safe somewhere does none of that. I’ve written a number of thought pieces on why I prefer exposure to the precious metal, but for the most in-depth explanation check: “Gold – The Currency of Last Resort”.

In a nutshell, the unprecedented level of monetary and fiscal intervention in capital markets has made the valuations we see today unsustainable for someone with an investment horizon of more than 10 years. Therefore, I resort to gold as the best way to preserve purchasing power, while having liquidity available for investment opportunities as they arise.

So far, the precious metal has been a terrific addition to my stock portfolio. Since I first presented my investment thesis in an article titled “Why Caution is Required Like Never Before and the Case for Investing in Gold”, the SPDR Gold Trust ETF (NYSEARCA:GLD) has returned nearly 50%, while displaying a negative correlation to broader stock market returns.

GDL Chart
Data by YCharts

Needless to say, my returns measured in British Pounds or Euros (which are the currencies I use) have been much better over the period.

Reduced stock portfolio variance

As I said earlier, high yields aren’t necessarily what I’m looking for when buying gold, as long as my cash holdings don’t lose purchasing power.

Risk protection for the current financial system and overall risk reduction is by far the main reason I am exposed to the precious metal. As we see below, for the most part since 2014, the correlation between GLD and the SPDR S&P 500 Trust ETF (SPY) has remained negative.

Gold vs. S&P 500 Correlation

prepared by the author, using the Yahoo!Finance data form

Naturally, holding bonds for this purpose would serve one’s investment goals even better, but in today’s environment of financial repression, the traditional 60/40 portfolio is much less appealing.

To more clearly illustrate the benefits of holding gold as part of an equity portfolio lately, we could also distinguish between high momentum stocks and value companies.

In the chart above, we could see that the 6-month rolling correlation between GLD and SPY reached highs on August 25, 2021. This appears to coincide with when the gap between momentum and value stocks has also peaked.

Chart
Data by YCharts

This supports the thesis that holding gold as part of a portfolio primarily focused on value (lower duration) has greater benefits for an equity portfolio focused on high growth stocks (high duration) . This is illustrated by the historically lower correlation of GLD with iShares Edge MSCI USA Value Factor ETF (VLUE) compared to iShares Edge MSCI USA Momentum Factor ETF (MTUM).

Correlation VLUE and MTUM vs GLD

prepared by the author, using the Yahoo!Finance data form

Avoid narratives

Whether preserving purchasing power, reducing equity risk, or even speculating, one should clearly understand the long-term drivers of gold prices and avoid falling victim. of stories.

One of the most commonly cited reasons for avoiding the precious metal is its inverse relationship to real interest rates (see chart below).

real interest rates relative to gold

Fred

Extremely low negative nominal and real interest rates are considered unsustainable in the medium to long term. Therefore, the chart above looks scary and is reason enough to deter many people from buying gold.

While this inverse relationship is indeed strong over short-term periods, it is not the only driver of gold prices, especially when risks to the current monetary system are high. I explain this process in detail in my thought piece titled “Gold: Still Haunted by Misconceptions”, which I highly recommend to anyone interested in learning more about the long-term drivers of gold.

The yield on US Treasury Inflation-Protected Securities (TIPS) is now just below the zero boundary, a level we last saw in mid-February 2020 (just before the pandemic hit) .

TIPS Yield %

Fred

At the same time, the GLD is 23% above its February 2020 levels.

Chart
Data by YCharts

As we reach the end of the line of the current monetary regime, the price of gold will likely decouple further from real interest rates. No matter what the future holds, whether it is the creation of a global digital currency, a system based on a “Bancor” type currency as proposed by Keynes as an alternative to Bretton Woods or the creation of an alternative monetary system revolving around Russia and China. , the risk to the current monetary system will likely continue to rise and with it the demand for safe-haven assets.

This also helps explain why the price of gold has not soared in the face of the very high inflation we are witnessing. In the graph below, we can see that during the 1970s, the rise in inflation was also accompanied by an increase in the velocity of money.

IPC vs Velocity of M2

Fred

On the contrary, the current surge in inflation is less of a monetary phenomenon. It is largely caused by fiscal stimulus in 2021, supply chain issues and geopolitical risks. However, this does not necessarily mean that we cannot see a spike in the velocity of money in the coming years, which will keep inflationary pressures high. If that happens, the price of gold will have yet another tailwind on its back.

Conclusion

Gold continues to perform exceptionally well while being a great addition to an all-equity portfolio from a risk perspective. While most narratives around gold have some merit, relying on rising real interest rates, high inflation, or geopolitical risks as a reason to invest in or avoid gold is for least suboptimal behavior. Likewise, holding gold in the hope that it will reach $5,000 an ounce and make you rich is also madness. Where the precious metal really shines is in preserving purchasing power during times of high risk and uncertainty around the existing monetary system. A period that we are certainly living in now.