Gold. A shiny rock which, from time immemorial, has fascinated our simple species by virtue of being relatively rare and similar in color to what we belatedly identified as a dying star.
When it comes to indicting humanity for being dense, cruel and acquisitive, the history of our relationship with gold is among the most damning available evidence. The list of atrocities committed in the name of gold includes every capital offense in the US penal code and every crime ever considered in The Hague.
None of that is gold’s fault, of course. If it could think and talk (i.e., if it weren’t an inert metal) gold would probably express something like despairing incredulity at our fatal attraction. It might even seek a restraining order.
Unfortunately, the idea of a gold-backed global commerce system is en vogue again thanks in no small part to one well-known analyst’s increasingly belabored efforts to enshrine himself in economics textbooks via a convoluted modern day mercantilism. But, as I not-so-gently reminded readers last week,
A gold standard is conducive to more, not less, macro volatility. When you handcuff yourself to a finite metal, the government and the banking sector are constrained in their capacity to expand and extend credit. That can be ruinous. Reverting to such a system is a total non-starter in modernity. Choosing that path would guarantee the return of episodic depressions (with a “d”) in developed economies, and new gold discoveries (assuming there are any left) would lead to unpredictable bouts of inflation.
From a geopolitical perspective, a gold standard is, by definition, zero sum. Unless you discover new gold, there are only two ways of obtaining it for state coffers: Through trade or through war. What proponents don’t mention is that exogenous money is, historically, conducive to conflict.
In short: You don’t want a gold standard. You really, really don’t. Anyone who tells you different is lost in their own theories, ignorant of history, pushing an agenda you’re not apprised of or some combination of the three.
But, gold does serve a purpose as a store of value (thanks almost entirely to our childlike fascination with it) and, more importantly, as a portfolio hedge. Contrary to popular belief, I do own some gold. Just like I do own some Bitcoin, and some Ethereum, and some Solana, and some other crypto assets I wish I didn’t own, but which are impossible to sell because there’s no liquidity. (As it turns out, the NFT crowd doesn’t have the same definition of “secondary market” as the rest of us.)
Why do I own gold? Well, I often ask myself that, especially when inflation is running 8.5% and my paper gold isn’t rising on a trajectory that would put it close to that dying star I mentioned here at the outset. Jokes aside, I own gold because it can be (with an emphasis on “can”) a negatively correlated asset. And you want some negatively correlated assets, especially at a time when diversification desperation makes them harder to come by.
Ironically in that context, gold’s Achilles’ heel is its antithetical relationship with US real yields which, you’ll note, turned positive at the 10-year sector for the first time in the pandemic era late Tuesday (or early Wednesday, depending). The figure (below) shows just how dramatic the recent rise out of negative territory has been.
Most of the focus is on the read through for equities, which is understandable. “The implications from higher real yields on financial conditions are obvious and as we see the GS FCI measure within striking distance of the March 14 peak, there is a compelling reason for investors to offer concern regarding the potential ramifications for other asset classes,” BMO’s Ian Lyngen and Ben Jeffery said Wednesday, noting that “thus far, the equity market has remained remarkably sanguine with little sign of the skittishness that one might have otherwise anticipated.”
For gold, higher real yields are kryptonite. While one might be inclined to suggest the extremely challenging geopolitical landscape and still elevated inflation in developed economies make the case, market drivers may take precedence soon enough, especially considering the notion that other commodities are far better positioned to hedge inflation given current macro realities.
The figure (below) is from RBC’s Christopher Louney who, on Wednesday, wrote that although gold “can and does perform well in the context of extremely high and uncontrolled inflation in the short-term,” if it’s durability you’re looking for, energy, agricultural and industrial metals commodities may be a better bet given their “stronger relationships with inflation on a sustained basis.”
Louney isn’t bearish, but he did underscore the idea that market drivers are lining up against the yellow metal.
“While the search for stores of value and perceived safe havens has kept gold prices elevated, higher interest rates are at least capping gains and will likely take their toll eventually,” he wrote. “Likewise, alongside higher bond yields, a stronger dollar and tightening monetary policy globally, macro headwinds will likely make their weight known.”
That speaks to a problem I’ve identified on countless occasions previous. It’s obviously true that gold has held its value over time, but it’s far from obvious that it’s appreciated as much as it “should” considering the total abandonment of sound money over the past several decades.
The Fed’s balance sheet has ballooned to $9 trillion and, as the figures (below) make abundantly clear, the US jettisoned every pretense to fiscal and monetary rectitude during the pandemic.
To speak colloquially, if that wasn’t enough to send gold into the stratosphere, it’s not clear what would.
Gold hasn’t staged anything like a Bitcoin-esque rally during the most gold-friendly macro conjuncture imaginable (i.e., unbridled “money printing” to finance massive deficits alongside rampant inflation). In fact, it’s sitting a mere ~16% above pre-pandemic levels on the eve of the most aggressive Fed tightening campaign since Volcker.
Considering the implied scope (and pace) of Fed hikes, it’s not difficult to imagine gold falling back into one of its maddeningly meandering ranges, assuming the Fed succeeds in getting rates back to neutral and shrinking the balance sheet.
That’d be a somewhat disappointing outcome for gold bulls considering all that’s happened. The stars aligned for gold and it didn’t even go to the moon, let alone reach its celestial color cousin.
You might protest that, in gold’s defense, it’s up 5,000% over the past half century. That sounds great until you consider that its new age competitor is up that much in five years.
Of course, not everyone agrees that Bitcoin is a competitor. And on that note, I’ll leave you with a short passage from Goldman’s Mikhail Sprogis. To wit:
Crypto and gold are not competitors: With restrictions on capital flows and sanctions on Russian financial institutions and oligarchs, the role of cryptocurrencies as a way to avoid these restrictions has come into focus. Indeed, many Russians could take money out of Russia using cryptocurrency after the country introduced capital flow restrictions. At the same time, assets of some Russian oligarchs were frozen by western authorities. Crypto assets cannot be simply frozen as their ledger is decentralized. In this respect, crypto is more efficient than gold as it is challenging to transport physical gold bars and gold stored in bank vaults can be frozen similar to bank deposits. However, the vast bulk of gold investors hold it not to avoid sanctions or capital restrictions but to preserve real purchasing power and hedge risks of currency debasement. In terms of its use for avoiding government restrictions, crypto is competing with cash which is more often used to facilitate unpermitted transactions. As we have argued before, gold is a defensive asset while crypto is a risk-on asset. Therefore, we think the uses and buyers of crypto and gold are very different and there is little competition between the two.
Thanks for doing your Joe Friday.
Simply stated.
“Crypto assets cannot be simply frozen as their ledger is decentralized” Sprogis There may still be some difficulty converting it to usable funds.
Friedman’s k-percent rule. Put it in the Constitution.
Wouldn’t that have the same effect as the gold standard and turn into a vicious cycle? If you had a recession, you’d be tightening monetary policy which would essentially send the economy down the path of depression. I’d hate to think what would’ve happened if we had applied that rule during the early phases of the pandemic.
I suppose you could set parameters to ensure that it’s always a positive number, but still, I’d imagine that wouldn’t have prevented the credit markets from freezing up.
Cypto is essentially privately issued currency. That asset has a long history of failure. I cannot bring myself to hold a commodity like gold- no real return and even less utility in the real world. As a hedge, I finally threw in the towel and for some retirement funds of my clients I own gold mining stocks as a stock sector with a low correlation to other stock sectors. As for other commodities, they have some hedging value but generally long term have poor returns. There are really 4 good assets to invest in, from my point of view in the securities markets- stocks, bonds, real estate, cash or near cash, and maybe you can carve out a category of some sort of floating rate or inflation protected bonds as a subset of bonds that behave a bit differently. Very high net worth investors can play in other swimming holes but for most investors those 4 are the choices that seem to make the most sense.
I could not have stated this better.
RIA, if I ever decide to use an investment advisor, I would use someone who sees things as you do.
Regarding crypto, just yesterday Bruce Schneier (one of the world’s leading cryptographers) said on his blog “It is insane to me that cryptocurrencies are still a thing”.
I doubt that I will ever own any cryptocurrencies. They are just numbers in a computer. As a security expert, I know all too well that no matter how well people have designed crypto systems, getting it right when implementing it is extraordinarily difficult. I much prefer a gold bar that I can tuck away.
True to the age old advice, I used to invest about 5-10% of my portfolio in gold going all the way back to the 1990’s. Over the years, that advice served its purpose, as gold tended to gain when all else was failing, and I usually sold it at a profit. I tried to buy physical gold at the start of the pandemic, but there was simply none available to be had. Prices rose, but never “spiked” the way you might have expected given the obvious scarcity. Silver was still available, but had less appeal because of its much lower value, and its checkered history as a store of wealth. In the absence of gold, platinum went through the roof, and copper futures went on a mad tear. More and more, people turned to digital assets such as Bitcoin–the new “digital gold–as they appeared to be working the way gold should have, only with outsized results. I have monitored Bitcoin throughout the pandemic period, and it behaves much more like a volatile risk asset than any “store of wealth” IMHO. Gold has moved in a more predictable pattern, but I agree its moves have been more muted than in the past. I think difficult availability, the process of obtaining it from dealers, and the cost of renting a safe deposit box for secure storage deters many potential investors. I also think that gold just could not compete with FAANG stocks during that same period. I do not know what the availability of physical gold is now. I still avoid Bitcoin. Call me old fashioned, but if I am going to plop down thousands of dollars to buy “coins,” I want to be able to hold them in my hand and marvel at their age, color, and beauty.
I started buying physical gold about ten years ago. I intended to put a solid proportion of my portfolio into this vehicle but I couldn’t buy any quantity at any local dealer, even in a top 20 city. They buy but they don’t sell much. So I stopped. My basis is about 1200/oz so I have made a bit of money. I also have a platinum bar and a bunch of silver with a low acquisition cost but even 100 silver ozs isn’t worth much. I do keep my gold where I can either wear it or touch it because it is beautiful.
Just loved the opening–very well written. One problem for Gold is the lack of a way to accrue interest, which bolsters the total return over time. Finally, the relationship to real rates is slighly more nuanced. If you running a rolling correlation you will find that the correlation to real rates often changes sign or weakens dramatically during rate hike cycles.
Angry One – in the old days, large holders (like Central banks) would lend bullion to arbitageurs and such to earn a small return. Not sure if that is still commonplace.
In the meantime, central banks still hold substantial amounts in their reserves. Any CB looking to diversify out of the banking system does not have many other choices.
I suppose you could own GLD and SLV and sell out of the money call options against to generate some “return.” Of course to do that you need about $18k to own the 100 shares to sell one call against (cheaper for SLV). The downside of course is the missed opportunity of GLD/SLV blowing up, but seems like both are capped for right now (GLD at 190ish, SLV at 25). H’s point on reals is spot on.
I own no gold other than in jewelry and that is not much, as I prefer silver and platinum.
However, as I am becoming more involved in assisting my parents ( still relatively independent at 88), I find it ridiculous that they have held gold in their safe deposit boxes for decades. Every now and then, my dad likes to go look at it to verify existence, even though I keep a very detailed document of everything related to their investments, accounts, etc.
After we look at and count the gold , we go back to my parents house and I look up the price of gold to see what it is worth. Next, I ask him how he will use gold to buy anything he needs or if he wants me to help him sell it- which generally ends the conversation with a good laugh— but the gold remains in the safe deposit box.
It can and has been argued that the reason gold and other precious metals are being kept at artificially low valuations is because of the aforementioned “paper” versions of these assets. With many investors not being inclined to possess actual physical versions of the precious metals, they find it more convenient to own paper versions of them instead. These paper versions are supposedly reflections of an actual gold asset but I doubt anyone is auditing any of these paper assets to ensure they are actually backed by the appropriate amount of physical gold. What would be an interesting exercise is to see some kind of a run on paper gold assets, large percentages of paper gold holders cashing in simultaneously. Methinks this type of an event would expose the fraudulent nature of paper precious metals and then you would see the actual value of gold, silver, platinum, etc. revealed. As stated, the value of gold has not really changed in line with increase in available USD currency, it’s not like we’re creating more gold.
What is that “actual value”? This is why I continually say that gold is most useful as a portfolio hedge and little else. It has no “actual value” in a doomsday scenario, or any other scenario, really. Its “value” is almost solely a function of our fascination with it. If you were to rerun history a million times, there’s no guarantee that our species would decide on gold as a store of value in each and every one of those reruns.
No idea what the actual value of gold is. That’s kind of my point. It is still viewed as a store of value globally, foreign governments continue to accumulate and invest in gold as a store of value. All money value is a factor of our fascination with it, cacao beans, gold, silver, tokens, dollars, points, etc. You could rerun history a million times and find that no one cares about dollars either. However the fascination with gold continues almost unabated for far longer than any fiat currency has ever survived. I think from a purely longevity perspective gold warrants more consideration than any other hedge. The fact that gold’s value is based on the supply of physical gold but also the value of “paper gold” which could be considered fiat gold, shouldn’t be discounted. At the end of the day, paper gold is as worthless as rubles will be unless the supposed physical gold backing is available to exchange. The more I think about it, the more that it seems paper gold is closer to gold backed dollars than it is to actual gold.
Oh, don’t get me wrong, if you reran history a million times, there is a much better chance that gold emerges time and again as “money” than US dollars. Indeed, there’s virtually no chance that US dollars would even exist in an alternate version of history because it’s impossible to imagine history ever evolving in such a way as to make the “US” a thing on any rerun.
always an interesting conversation and read…I think today’s main relevance (as a portfolio hedge) in developed economies is that gold may outperform in a stagflationary environment, something we haven’t experienced in decades…next question is how much tightening the FOMC will actually be able to accomplish…? … how high will real rates get…?…and lastly while I haven’t traveled since early 2020 my recollection from emerging markets that lack reserve currencies is that gold (and silver) has far more importance of being a store of value in currency devaluing / global inflationary times…we shall see….thanks, H. et al…