It hasn’t been a tumultuous week politically or socially, at least not to the degree I feared seven days ago, but gold has been all over the place.
I’ve had lots of conversations in the last week about why gold isn’t doing better. Would that I had a clear answer! Some ideas…
That’s what happening. What’s coming?
It totally depends on inflation (or reflation, if you prefer the term that specifies inflation stemming from stimulus). And it’s very hard to know how that will go.
Lots of economists and talking heads are certain all the stimulus spending will create inflation. I hope they’re right. But there’s one data point that stands directly in opposition to that: velocity of money.
The above chart is from Hoisington Investment Management, whose economists (Van Hoisington and Lacy Hunt) are renowned for their macroeconomic analysis. The pair do not think stimulus will generate inflation this year because
Hoisington and Hunt conclude that bond yields will continue to fall (which is a pro-gold conclusion) but that inflation will not manifest (which doesn’t help gold). As a result, they are bullish bonds for price gains.
That game has worked well for several decades. As they point out in their latest quarterly letter: “in a short 12 months the 30-year US Treasury realized a 20% return, compared with 18.4% for the S&P 500.” And the game works just fine for gold. If investors keep buying bonds for returns, bond prices will keep rising and yields falling.
When I talk about ‘real rates’ I point to nominal interest rates minus inflation, but the market watches real yields just as, if not more, closely. Those are bond yields minus inflation. Hoisington and Hunt may not think inflation is coming to help but they see yields continuing to fall, which supports the argument for gold nonetheless.
I diverged into all of that because I spend a lot of time thinking about inflation and whether it’s really going to rear up in 2021. I’m torn. Thankfully, arguments like this reinforce that it doesn’t really matter. Sure, inflation would help the argument for gold. But rates are rock bottom already so real rates are already well negative while real yields are close to and falling.
The fact that investing in bonds has become a price game, rather than a yield game, changes the rates argument for gold somewhat. It used to be that negative rates pushed investors away from bonds because the reason to buy bonds was for yield. Now no one buys bonds for yield, so that argument is less persuasive.
Instead, the argument is that the immense debt issuances and debt loads that changed the bond game create a different need: to hedge in case of crisis. I am not doomsday-er but today’s big picture doesn’t make much sense. Sky high equity prices in a recession. Huge demand for zero-yield bonds when debt loads are already immense. Central government debt standing at 127% of GDP, well in choking-off-growth territory. COVID-caused small business bankruptcies left and right. On and on.
The markets can stay irrational far longer than I can stay solvent so I’m not betting on an imminent crisis. But I also am far from alone in wondering if, when, and how a straw might break this camel’s back. Gold is an answer to that worry.
And even though the rationale for the yellow metal being perfectly inversely correlated to real rates is weaker today than it was 20 years ago, the relationship remains very strong.
Bond have been a price game certainly since the Great Financial Crisis and yet the pairing remains strong!
Going back to those first points I listed…
The gold argument still makes a lot of sense. Real rates and real yields support it, now and looking ahead. Diversifying against the irrationality of today’s market supports it. Gold miners making oodles of money and offering some of the strongest balance sheets and dividend yields across equities support it.
Inflation would amplify all of these, but it’s not needed.
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