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What has been puzzling to investors is gold’s dismal price performance over the last year. The price of an ounce has declined almost 10% to a recent US$1,775 per oz., while CPI has been accelerating steadily, despite the best efforts of central bankers to declare that the current inflation is “transitory.” Traditionally regarded as a safe haven when inflation is rising, as occurred during the 1970s and in the early 2000s. But this time around gold seems to be missing in action.
With inflation hitting decade highs in the U.K., Germany, and Canada, it’s apparent that regardless of the cause of the increase in prices, CPI rates are well above central banks’ 2% target. Mr. Powell has moved to targeting a 2% CPI average over time, so with Covid reducing CPI well below 2% in 2020, he feels the Fed can let it run well above that rate for a while and still attain the 2% average. How well this will be received by consumers experiencing sticker shock at the gas pump and at the supermarket remains to be seen.
Still, traders have not flocked to gold as they have done during previous bouts of rising inflation. Having recovered from a bear market low of $1,050 in 2015 to briefly top $2,000 per oz. last summer, gold now again trading below $1,800. Gold miners have done even worse, with the iShares S&P/TSX Global Gold Index ETF (TSX: XGD) off 27% in the 12 months ending Sept. 30, even though gold miners have been recording substantial increases in profits and paying decent dividends to their owners.
Some observers feel the reason is that gold’s role as a store of value that does not rely upon the money-printing designs of central banks has been replaced by cryptocurrencies such as Bitcoin and Ethereum. Bitcoin has continued to be exceptionally volatile, rising above $60,000 a coin before halving to $30,000 this past July. Subsequently it has risen again to over $60,000. Having risen over 300% in 2020, after losing almost three quarters of its value in 2018, Bitcoin remains one of the most volatile of all assets. Signs of increasing acceptance by authorities, such as El Salvador’s botched introduction of Bitcoin as a legal means of exchange, conflict with the dangers of crypto exchanges being hacked and statements such as the ECB’s President Christine Lagarde that “cryptos are not currencies, full stop.”
It’s understandable that in today’s excitable investing environment, inexperienced investors will be drawn to assets that move dramatically and that make claims to protect investors’ purchasing power. The danger of central bankers’ thesis that rising inflation is only transitory is that this may not be correct and that inflationary expectations may become entrenched, as happened in the 1970s. If consumers expect prices to rise, they will buy more now, pushing up prices, even if they don’t use the goods immediately. The psychology was demonstrated last spring with the phenomenon of a “run” on toilet tissue during the initial wave of the pandemic.
Gold has proven to preserv its purchasing power over the last three millennia, unlike cryptocurrencies, which have barely a decade of history. While gold does not produce income, in today’s minuscule or negative interest-rate environment, this is not a major handicap. Many established gold mining stocks actually pay dividends, which represent a yield of over 1%-2%.
Using a exchange traded gold ETF, such as SPDR Gold Shares (NYSE: GLD), investors can buy one-tenth of an ounce of the metal with none of the storage, insurance or security issues involved in owning the metal itself. Incidentally, gold has industrial uses, such as dentistry and solar panels, as well as jewellery demand to support its price. Finally, numerous central banks such as China, Russia, India, and Brazil have been buying substantial amounts of gold to add to their reserves, while China and India are cracking down on the ownership of cryptocurrencies. German retail demand for gold was the highest in 12 years in the first half of 2021 as deeply negative interest rates made it more attractive.
Any well-diversified portfolio should contain assets that are not (or negatively) correlated with other asset classes to both reduce volatility and to improve overall returns if one major class is suffering. The traditional 60% equities/40% bond diversified portfolio fulfilled this role successfully for most of the last 40 years, as rising interest rates were negative for bonds but generally positive for equities, as the economy was growing, and vice versa as growth slows.
The yield from the bond allocation traditionally provided income and dampened down volatility. Now absolute yields are so low (1.2%-1.5% in the U.S., Canada, and the U.K. and non-existent or negative in Japan and Germany) that they provide very little income, meaning that bonds now move in lockstep with equities, removing the benefits of non-correlation.
Gold is not correlated with equities or bonds but represents a store of value that will retain its purchasing power over time. Holding gold has been a tenet of absolute-return focused investors such as Swiss private banks for generations. In addition to gold ETFs, investors can now also look to gold miners, such as Barrick, Agnico Eagle, Franco Nevada, and Pan American Silver, which are profitable and pay decent dividends. This helps to address the need for a non-correlated asset and provides some income when investors are facing low interest rates.
With gold down almost 10% and gold miners off over 25% in the last year, despite excellent results, now is a good time to ask your financial advisor whether establishing or increasing a position in the sector fits with your objectives and risk tolerance.
Gavin Graham is a veteran financial analyst and money manager and a specialist in international investing, with over 35 years’ experience in global investment management. He is the host of the Indepth Investing Podcast.
Notes and Disclaimer
© 2021 by Gavin Graham. This article was originally broadcast as a podcast on Indepth Investing, hosted by Gavin Graham. Used with permission.
The commentaries contained herein are provided as a general source of information and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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