(This story was updated Wednesday to reflect the most recent market activity.)
Fear is here.
U.S. stocks are getting clocked as an inverted yield curve and fallout from the U.S.-China trade war are raising fears that recession will be here sooner than expected. The Dow Jones Industrial Average tumbled 800 points on Wednesday for its biggest loss of the year as major stock indexes tumbled 3%. Gold prices, in contrast, rallied to a six-year high, comfortably above the psychologically important level of $1,500 per ounce.
For investors looking to own gold to diversify their portfolios while protecting against potential market shocks, some notable endorsements may offer reassurance.
Granted, gold’s fiercest critics reflexively gag when the “barbarous relic” enters polite conversation. To them, gold can evoke a cartoonish caricature of the so-called gold bug, a wild-eyed, tin foil hat-wearing ignoramus who trembles with delight when fondling gold coins.
Yet, the most powerful of all gold bugs – central banks – purchased a record 374 metric tons of gold in the first six months of the year, according to the World Gold Council (WGC).
And last week, precious metals manager Sprott Asset Management agreed to acquire Tocqueville Asset Management’s gold equities asset management business, adding $1.9 billion in assets, including the long-running Tocqueville Gold Fund.
In an interview with Institutional Investor, Whitney George, president of Sprott, said last week, “Now the Fed is expected to cut rates at least two more times. And the trade wars look like they’re turning into currency wars with people worrying about currency devaluations. That has put the final nail in the coffin.” He added, “We’re now seeing the beginnings of a bull market in precious metals.”
Since bottoming a decade ago, the S&P 500 is up roughly 330%, while gold, which was recently priced at $1,520 per ounce, has gained about 60%. The S&P 500 is 5.5% below an all-time high while gold remains 27% below its 2011 high. Year-to-date, gold is outperforming, up 18%, compared to the S&P 500, which is 14% higher.
Though historically considered a store of value and insurance policy of sorts, gold occasionally launches into ripping long-term bull markets. From 1969 to 1980, the metal surged 1,755% and from 1999 to 2011, it soared 611%. Today, gold is 44% higher than Dec. 17, 2015, its lowest level in the past five years.
Amid mounting signs of a global slowdown, rates worldwide have been falling. Last week, India and New Zealand cut interest rates by more than expected while Thailand unexpectedly slashed rates. And on Friday, the U.K. unexpectedly announced that its economy contracted for the first since 2012, partly due to Brexit concerns.
Economically-sensitive commodities also point to slower growth. Brent oil recently touched bear market territory. And copper prices, often considered an economic indicator, fell this month to a two-year low.
Gold, which has no counterparty risk, has been attracting assets from spooked investors. The CBOE Volatility Index (VIX), which spiked 23% Wednesday, has surged 78% in the past three weeks.
Importantly, gold is facing dramatically less competition from interest-bearing securities. The 10-year U.S. Treasury yield fell to a three-year low of 1.57% on Wednesday and the 30-year U.S. Treasury Yield fell to a record low of 2.02%.
And about a quarter of the global bond market – a record high $15 trillion – offers negative interest rates. That’s well more than twice the $6 trillion figure from last October. About half of European government debt offers a negative yield.
Could negative rates arrive in the U.S.? “Whenever the world economy next goes into hibernation, U.S. Treasuries – which many investors view as the ultimate “safe haven” apart from gold – may be no exception to the negative yield phenomenon,” Joachim Fels, a global economic advisor for Pimco, wrote last week. “And if trade tensions keep escalating, bond markets may move in that direction faster than many investors think.”
In the current Barron’s, Larry Jeddeloh, founder of the institutional research firm TIS Group, said that he expects U.S. interest rates will fall to zero, asserting that European Central Bank rate cutting and the U.S.-China trade war have effectively tied the Fed’s hands.
With the U.S. economy slowing, and concern rising about the timing of the next recession, the Federal Reserve is in rate-cutting mode for the first time in more than a decade, emboldened by low inflation. And President Trump is openly criticizing the dollar’s strength and relentlessly browbeating Fed Chairman Powell for not cutting rates by more, and sooner.
Hedge funds are also bullish on gold, with optimism at a three-year high, according to data published Friday by the U.S. Commodity Futures Trading Commission data. Paul Tudor Jones, citing concerns about inequality, tariffs and recession, said in June that gold was his top investment for the next two years. “It has everything going for it when rates are conceivably going to zero. In that situation, gold is going to scream.”
Jeffrey Gundlach, CEO of DoubleLine Capital, which manages $140 billion, last week put the odds of a recession before the 2020 presidential election at 75% and said the yield curve is “full-on recessionary,” according to Yahoo Finance. He also said that if the volume of negative interest rate bonds outstanding increases at its current rate, that gold would likely rise, too, possibly to $1,600-$1,700 per ounce.
Ray Dalio, founder of Bridgewater Associates, which has $160 billion in assets under management, wrote last month on LinkedIn that investors had excessive exposure to stocks and other assets and not enough to gold, citing an expected “paradigm shift.”
“The big question worth pondering at this time is which investments will perform well in a reflationary environment accompanied by large liabilities coming due and with significant internal conflict between capitalists and socialists, as well as external conflicts,” Dalio asks.
Per gold, Dalio asserts, “Most investors are underweighted in such assets, meaning that if they just wanted to have a better-balanced portfolio to reduce risk, they would have more of this sort of asset.” Dalio concludes, “For this reason, I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.”
Central bank purchases of gold by volume last year were the most since the gold standard was abandoned in 1971, according to WGC. China and Russia, both bidding to reduce their dependence on the dollar, have, in particular, bought aggressively. China’s central bank has grown its gold reserves for eight consecutive months, through July. And Russia’s gold reserves pierced the $100 billion mark last month for the first time. Overall gold demand rose 8%, year-over-year, in the second quarter, to a three-year high due mainly to central bank purchases, according to WGC.
Though gold is at its highest level since 2013, it has risen just 14% in the past six years. Of more significance, gold is gaining momentum, up 27% in the past year – and trading above its 200-day moving average –while real interest rates (nominal inflation rate minus inflation) remain low.
According to WGC, “Historical gold returns are more than twice their long-term average during periods of negative real rates.” That’s partly because in a low real rate environment there is less opportunity cost involved with choosing gold over other assets. Bitcoin, also presumably a beneficiary of low real rates, has surged 65% in the past year, with some investors arguing that it is “positively correlated to gold.”
In the short term, gold could be vulnerable, given recent strength and decidedly positive sentiment. Longer term, gold could provide value as a diversifier in portfolios, while possibly delivering strong capital appreciation.
Popular gold exchanged-traded funds designed to track the metal include the SPDR Gold Shares (ticker: GLD), iShares Gold Trust (IAU), Aberdeen Standard Physical Swiss Gold Shares (SGOL) and Sprott Physical Gold Trust (PHYS). Among the largest gold mining ETFs are the Van Eck Vectors Gold Miners ETF (GDX) and the Van Eck Vectors Junior Gold Miners ETF (GDXJ).
Despite a monster rally in 2011 that took silver to nearly $50, it is currently around $17 per ounce, slightly above where it was a decade ago. Gold has outperformed silver for a great many years. However, silver has perked up, rising 8.7% in the past month, compared to gold’s 6.6% gain. And given that silver is more volatile than gold, and generally correlates with the metal, if gold enters a sustained bull market, silver could outperform. Moreover, the gold to silver ratio, which reflects how many ounces of silver it takes to buy an ounce of gold, stands at 88, far above historical levels, suggesting silver offers better relative value. Silver ETFs include the iShares Silver Trust (SLV), Aberdeen Standard Physical Shares (SIVR) and Global X Silver Miners ETF (SIL).
