Entering 2020, following a 10-year equity bull market (which was abruptly ended by Covid-19 in March), many investors were questioning the merits of owning gold within their portfolios given the significant out-performance of all the major stock market indices. As worries mounted over the spread of coronavirus, financial markets experienced sharp price declines with many investors quick to liquidate gold to cover margin calls. This initial credit contraction, where investors liquidated their gold holdings to repay their leverage, resulted in the metal declining for two weeks, adding further doubt to its “safe haven” status. Despite this, gold is currently up around 10% year-to-date, outperforming all major stock market indices, clearly demonstrating the metal’s value as a safe haven and as a valuable portfolio diversifier.
Since my October 2016 blog post, where I touched upon gold being one way to protect against depreciating currencies, gold has risen 35% while the S&P 500 is up 41% with dividends re-invested in USD terms (excluding dividends: 32%). Although a short period of time, it emphasizes Warren Buffett’s point that the “magical metal was no match for the American mettle” and eschewing stocks for gold is not a wise strategy. Nevertheless, when compared to other major stock markets (with dividends reinvested), gold has significantly outperformed in USD terms (Euro Stoxx 50 is up 2.9%, Hang Seng is up 16.9% and the Nikkei is up 18.2%)*.
I am not in the “sell-everything-now and buy gold” camp, nor a “gold bug”. I do, however, believe gold plays a valuable defensive role in portfolio diversification. Looking forward, my view is there are two major reasons to own some gold over the medium term:
- Increasing money supply driven by central banks “quantitative easing” programs, combined with rising government deficits to fund fiscal stimulus programs will at some point, result in meaningful inflationary pressures. To illustrate the magnitude of these programs, the U.S. Federal Reserve balance sheet now exceeds a record $6 trillion and continues to expand at a rapid pace. Furthermore, Congress has approved a $2.2 trillion stimulus package, the largest in its history, with further packages likely to follow to prop up the economy during this crisis. Other G20 governments are pursuing similar fiscal strategies during the unprecedented lockdowns forced by the pandemic as shown by the chart below:
I believe, at some point, debasement concerns will come to the forefront. Investors are likely to shift their focus onto the size of the major central banks’ balance sheets and the unsustainable fiscal deficits of some the developed (and developing) countries’, as well as their ever growing debt burdens. Similar events occurred in late-2008 when gold under-performed as credit contracted, before rallying to new highs as the Fed’s quantitative easing program took hold.
- Gold’s 0% yield, usually a disadvantage over owning bonds, suddenly becomes an advantage in an environment with real negative bond yields. To stretch for higher yields, investors are currently being forced to go further out the risk curve, exposing themselves to higher probabilities of default, resulting in situations where the risk/return profile is not prudent. To add to the difficulties of finding attractive yields, the Federal Reserve has started buying corporate bonds, in addition to High Yield Corporate ETFs, further suppressing yields that investors would otherwise demand to lend to borrowers of that nature. These lower yields risk being wiped out in real terms if inflation rises meaningfully.
These two reasons above suggest that gold is a good place to park a portion of an individual’s capital.
Note: Gold is commonly purchased through price tracking funds such as State Street’s SPDR Gold Trust, commonly known by its ticker ‘GLD’ or BlackRock’s iShares Gold Trust ‘IAU’. The two ETFs currently manage over $56 billion and $22 billion in assets, respectively.
Full disclosure: I am currently long GLD.
* Returns are as of market close on 16/04/2020
Disclaimer: The information posted above are my own personal views and should not be construed as investment advice. This material does not take into account your particular investment objectives. Investors should consult their own financial or investment adviser before investing or acting upon any information provided. Past performance is not indicative of future results.