Ben Bernanke’s views may be influenced by the historical use of gold by central banks in shaping international monetary policy and stabilizing exchange rates. In the past, the price of gold was fixed for currency purposes and the asset was relatively illiquid. Since 1973, gold prices have been allowed to float and starting in 2003, the creation of gold-based exchange-traded funds (ETFs) have provided a liquid way to invest. Just this year, through mid-September, over $8 billion flowed into U.S. based gold ETFs.
Although scorned as a barbarous relic with no productive cash flow, gold has interestingly kept up with other financial assets since 1973. Gold tends to shine during periods of stagflation, geopolitical disruption, and severe equity bear markets, while underperforming during periods that combine strong economic growth with low inflation. Research shows a correlation between changes in real (inflation adjusted) interest rates and changes in the price of gold – gold prices often going up when real interest rates go down and vice versa. According to Digital Asset Research, declines in real yields have explained roughly 20% of the positive move in gold prices since 1997. In the last 5 years, Kitco shows a much stronger 71% negative correlation between gold and US 10-year real rates - a period that may be more relevant given gold’s increased liquidity.
The correlation between assets that don’t produce their own cash flows (such as gold, bitcoin, art, collectibles, undeveloped land) and real interest rates makes intuitive sense. If real rates are 0% or negative, investors won’t be giving up as much when they consider alternative investments. Given the presence of negative bond yields in much of the world, it’s no wonder investors are further enticed to hold a non-productive asset (with potential price upside) over an asset that returns less than they paid for it at maturity.
While we often see gold perform well when confidence in sovereign paper currencies is waning, during wars, and when stocks suffer significant losses, that relationship can be trumped by the direction of real (inflation adjusted) interest rates. For example, in the second half of 2008 during the credit crisis and Lehman’s bankruptcy, one might have expected gold to rally. However, instead of rising in response to falling equity markets, gold prices fell likely due to rising real rates. Another contrary example occurred this past summer as the U.S. dollar’s strength (influenced by other flawed currencies backed by even more reckless central banks) failed to keep gold prices down. Instead, falling real interest rates likely urged gold prices higher in the face of the dollar’s strength.
Practicalities of the Gold Market
Unlike paper currencies, gold has a physically limited supply and cannot be easily diluted. Thus, gold has the potential of retaining its value better than other forms of currency. With ballooning U.S. federal deficits and the need to print money to fund those deficits, it is not surprising that central banks the world over are choosing to accumulate gold over dollars, despite the dollar’s role as the world’s reserve currency.
According to a survey by the World Gold Council, central banks use gold for several purposes: as a safe haven asset, as an effective portfolio diversifier, to improve risk-adjusted returns and as valuable collateral. In the first six months of 2019, central banks added 374.1 tons of gold as Russia and China kept building reserves and Poland made a massive purchase. Further, the gold reserves of the German Bundesbank rose in September 2019 for the first time in 21 years. While the amounts are not huge at 90,000 troy ounces, it highlights the Bundesbank and German concerns about the global monetary system and euro itself. The International Monetary Fund (IMF) data shows central banks continued their 2019 gold buying programs in September with the UAE, Kazakhstan, Belarus and Turkey all adding to their gold reserves.
Gold in Current Times
Our investors and friends know we incorporated gold into portfolios for similar reasons to the global central banks, initially adding the commodity to accounts in September of 2018. Given gold’s recent dip, largely due to technical factors, we thought it was an opportune time to revisit our view on gold in the current environment. With increasing levels of world debt and the need to fund it, low real yields may be with us for some time, which may be reason to include gold as a part of your overall investment strategy. And we leave you with this thought as we enter the new year, if people weren’t worried about flawed currencies, why was bitcoin invented?
Nothing contained herein is intended to be a formal research report, or as a source of any specific investment recommendations and makes no implied or express recommendations concerning the manner in which any accounts should be handled. Any opinions expressed in this material are only current opinions and while the information contained is believed to be reliable there is no representation that it is accurate or complete and it should not be relied upon as such. Investing involves risk, including loss of principal, and no assurance can be given that a specific investment objective will be achieved.
2x Wealth Group is a team at Ingalls & Snyder, LLC.,1325 Avenue of the Americas, New York, NY 10019-6066. (212) 269-7757