How Sustainable Is the Gold Rally?
Art by Sam D’Orazio
A store of value since ancient times, gold is again a go-to investment as the global economy weakens and the US-China trade war worsens. The price of gold has risen 42% since its decade nadir in 2015. And last week, as the tit-for-tat trade tiff escalated, gold blew past $1,500 per Troy ounce.
“This is a flight to safety,” said Ed Egilinsky, head of alternative investments at Direxion, noting how the yellow metal has languished for years until events propelled it aloft. “Gold has broken out of a six-year range, central banks are purchasing it, investment inflows into gold ETFs are strong,” he said.
Nowadays, a chorus of big-time financial voices are singing the praises of what legendary economist John Maynard Keynes once dismissed as a “barbarous relic.” Hedge fund kingpin Ray Dalio in July said rocky times are bringing a “paradigm shift” to markets and buying gold is “risk-reducing and return-enhancing.” French bank Société Générale last week even went so far as to recommend that gold make up 14% of a portfolio.
Amid such enthusiasm, gold may well rocket still higher in today’s unsettling world. Louise Yamada, who heads her own eponymous advisory firm, believes it soon will reach $1,800, the 21st century record set in 2011 (it attained an all-time, inflation-adjusted peak of $1,993 in 1980).
Here’s the funny thing about gold, though: Don’t count on it to maintain this high-flying level for the long-term. It’s very volatile, charging skyward when economic downturns, inflationary spikes, and international turmoil show their hideous faces.
When the world seems more benign, gold tends to lag. After the recession ended in the early 1990s, the international economy took off and the world seemed free from major conflicts. Those were not good days for gold investors, pointed out Jim Besaw, CIO of GenTrust. Back then, “gold went for $300,” he added.
In summer 2019, there’s no such blissful serenity in the social and financial order. Leery American investors aren’t the only ones charging into gold. Capital flight from China and emerging markets are likely helping lift its price, too, the Jerome Levy Forecasting Center says. Similarly, the chaotic pending separation of the UK from the European Union has prompted a rush of British money into gold exchange-traded funds.
Gold’s Problematic Investment Past
Since the financial crisis, gold’s price has been on a wild ride. In the nervous, slow-growth years right after the Great Recession’s late-2009 finale, the price shot up. The European sovereign debt crisis, beginning in 2010, fueled it further—with gold hitting a high of $1,800.
Then it ebbed in the middle of the decade, as other commodities lagged, with a low point of $1,060 in late 2015. “The US and the European economies were seen to be improving, so the risks were down,” said Jean Carlos Artigas, director of investment research at the World Gold Council.
But with the trade war’s onset in 2018, gold climbed anew. The face-off between the world’s two largest economies has unnerved nations from Europe to Asia, which already were eyeing a slowdown. Add tumbling interest rates to this noxious brew, and gold gets another leg up. Normally, if rates dip, gold benefits. While gold, like other commodities, offers no interest or dividends, falling rates betoken economic distress.That is the situation worldwide, and in late July, the Federal Reserve reversed itself and joined the easing trend.
Further, if the dollar drops, gold rises, as well. The metal is denominated in US currency, which makes it more accessible for foreign buyers. Right now, with a strong greenback, the US currency is not a factor. And gold also climbs if the stock market slides, which equities did for at least part of last week, when gold topped $1,500.
How gold stacks up against blue-chip stocks and investment-grade corporate bonds depends on what period is being measured. By Investopedia’s count, over the past 30 years, gold was a laggard, up 335%, while the Dow Jones Industrial Average increased 1,255% and the Fidelity Investment Grade Bond Fund returned 672%. Go back to include the stagflation-ridden 1970s, and gold comes out ahead.
Go back 100 years, and stocks vastly outshine gold. That’s the conclusion of Jay Kaeppel, director of research at Alpha Investment Management. He calculated the inflation-adjusted returns three years ago and found that, over the preceding century, gold increased in price about 2.5 times while the Dow was up nine-fold. Both are up a lot since, but it stands to reason that equities’ overwhelming out-performance has stayed intact.
As a diversifying investment, gold has greater utility. The substance is not correlated to stocks (which are supported by corporate earnings) or bonds (which rest on companies’ ability to service debt). So, as one school of thoughts holds, comparing it to equities and fixed-income may not he that helpful to investors.
Gold as an Inflation Hedge
But compare gold to the dollar, whose value generally tracks inflation, and a different picture emerges. Over long spans, the metal does seem able to serve as an inflation buffer. When the gold price is measured over 100 years, adjusted for inflation, it bests the dollar’s value, said Besaw of GenTrust.
Trouble is, gold’s fluctuating nature can make it less effective as an inflation hedge over shorter periods. Since the early 1970s, the ratio of gold’s price to the Consumer Price Index swung around from a low of 1.47 to a high of 8.68, a study by Duke Professor Campbell Harvey and former TCW portfolio manager Claude Erb concluded. As a result, the CPI would have to be 41% higher than the current reading to justify gold’s price now, they contended.
In addition, stocks are a better inflation hedge than gold as earnings tend to accelerate when inflation heads up, North Carolina State Professor Richard Warr found. In 10-year periods since 1871, earnings growth rates on an inflation-adjusted basis were 21% less volatile than on a nominal basis, which Warr argued indicated a superior ability to hedge against inflation. He did concede that, over short inflationary periods, such as a year or two, stocks tend to lag. Gold, of course, surges higher then.
Gold’s Place in History
The Romans and other ancient civilizations used gold coins as a means of exchange. Weighty and shiny, gold was the one metal whose value all could agree on. For a long time, the US dollar was pegged to gold, as a means of stabilizing the greenback. This had the controversial effect of tamping down inflation. The US Treasury fixed the gold price at $20.67 in 1879.
At the 1896 Democratic national convention, championing cash-poor farmers who wanted some inflation to ease their debt burdens, William Jennings Bryan catapulted himself to his party’s presidential nomination. With a broadside against the gold standard, he wowed the delegates by proclaiming “you shall not crucify mankind upon a cross of gold.”
Slowly, the link between gold and the dollar began to erode. To combat the Great Depression through expansion of the money supply, President Franklin D. Roosevelt ordered the confiscation of all gold bars, coins, and certificates (people got paid the $20.67). The commandeered metal was stored at the Fed, and Congress jacked up the official price to $35. That gave the Fed extra power to expand the dollar supply.
As World War II drew to a close in 1944, 44 nations concurred at the Bretton Woods conference to fix their currencies to the US dollar’s value, which in turn was tied to the price of gold. But in the postwar years, as money flowed freely around the world, the official gold price and the market price diverged. President Richard Nixon ended the gold standard in 1971.
Since then, gold has taken its place as a primo destination for investments when things get hairy. While today’s gold enthusiasts, known pejoratively as “gold bugs,” advocate a return to some kind of gold standard, buying and selling of the gleaming substance is the province of spooked retail investors and savvy speculators.
Institutions, which have a long-term view of investing, tend to avoid gold, or at least confine it to a small slice of their holdings, as a diversifier. That’s the case with the $154 billion Teacher Retirement System of Texas, which has less than 1% in gold. TRS includes the precious metal in the pension fund’s holdings, a spokesman said, “for its diversification benefits in portfolios dominated by equities, as most pension funds are.”
In the end, the volatile nature of gold prices doesn’t endear it to a big swath of investors. In inflation-adjusted dollar terms since 1920, GenTrust’s Besaw said, the price has swung from a low of $1 to a high of $11, with the current level at $6.
In other words, at the moment, gold has a lot of room left to ascend. And it may well do so.
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