One of the most divisive issues in the world of investing is the place of gold and whether there is any value in having some exposure within a portfolio.
Ranging from the Buffet view of bullion being a completely useless investment tool given its lack of intrinsic value there are still others who claim that it is the only true form of currency. We take a somewhat middle of the road approach and suggest that it could serve as a useful insurance tool within portfolios precisely because of people's perception (i.e. very few products in the world have stood the test of time in the same way as precious metals). So this brings to us an interesting question, given the recent momentum in markets with gold breaking past the 1300 USD mark to 1402 USD, is this sustainable and is this then the time to buy?
Before answering that question, we shall start off with the disclaimer that TAMIM does not have any skin in the game, so to speak, with bullion or options exposure to the price of old. Whatever exposure we do have comes from owning gold companies whose cost of production is significantly below the 1000 USD mark and hence remain relatively profitable trades even should the price not continue upwards. Secondly, we would also like to suggest that answering this question is going to be one of the most complex tasks that one could undertake. Too often, the price of gold is often seen by investors as having an inverse correlation to economic turmoil or inflation, and while it is true that the price of gold as a whole does tend to do well during times of increased uncertainty, such a straightforward notion does not even begin to scratch the nuances and the plethora of factors that are at play.
For one thing, a logic like that would’ve led most investors to make some rather unprofitable trades even over the past 5 years. A simple view that there are elevated risks in the global economy does not necessarily translate into a bullish gold price. The last time gold hit 1800 USD mark was back in 2011 and gold has a fairly consistent track record of ensuring that you cannot get rich by trading it, it is exceptionally good when it comes to head-fakes (meaning just when you think there is a breakout it will bring us back down to earth), that is the irony of owning Gold.
Just because you think equity markets are not likely to do well over the coming years does not necessarily correlate to a gold trade. For example, the price of gold fell through the years of the dot com bubble. In fact, it was only in the years after the dotcom bubble burst and the Fed lowered interest rates sufficiently that gold rallied. This brings us to the biggest elephant in the room when it comes to the price of gold, it is an asset that functions when all other assets fail. In essence, gold rallied when the USD devalued enough for it to gather momentum for a short period of time before strength in the underlying economy and credit growth enabled a housing boom (we all know how that ended up). The next rally came through 2008 - 09 till around 2011.
So the first point about gold is that it is essentially a short USD trade. During periods of elevated risks and uncertainty, money first floods into US Treasuries and USD assets after which it moves to gold as a last resort. The reason for this is both historical going back to the days of Bretton Woods and intuitive given the functioning of the Eurodollar system as well as the status of the USD as the reserve currency of the world. Given the likelihood of the Federal Reserve lowering interest rates further, there is a certain logic that suggests that gold might have a perfect set-up for an upward break. However, the opposite argument is that given the stability in the underlying US economy, the USD might remain elevated for some time to come and hence act as a lid on the price of gold.
The truth of the matter, both of these arguments are valid. The fact remains (as we have constantly talked about over the past few weeks), given the low interest rate environment and the search for yield, risk assets across the board are trading at premiums and risks to the downside are elevated (and likely to be so for an extended period of time). In this environment, it is more likely than not that gold will also track at a premium as more investors and traders alike look to hedge their risk exposure by using gold. However, whether this means that there is further momentum remains to be seen. We haven’t seen the data as of yet, but our gut feeling remains given how quickly the spot prices ran up, that most of the recent price action might be existing bullion traders doubling down on their exposures in the lead up to the potential for further rate cuts. They might be proven right, but rather by pure luck or coincidence (as the old sayings go, if you say it long enough eventually you’ll be proven right and even a broken clock is right twice a day).
The missing piece of the puzzle for gold over the past few years has been inflation and the strength of the dollar squeeze. Believe it or not, the lowering of interest rates and quantitative easing did not as one expected create liquidity but rather a shortage of dollars as private investment was effectively crowded out (a similar strategy used by the Europeans). One of the key aspects of the USD strength has also been the propensity of central banks around the world (including the Chinese and Japanese) to buy US treasuries thus keeping up enough of a demand for USD to keep treasury yields low and allowing for more and more fiscal expansion. All this ended with the result that asset prices continued to tick up but core inflation remained restrained. Until such time as this dynamic changes substantively we would suggest that gold is not going to have its day in the sun by ratcheting up to $5000 USD or even $1800 USD.
The final step in this loop will be to see how governments around the world continue to interact over the next few years. We can be certain that eventually there will have to come a time when central bankers have beaten the system until something breaks. Whether it is the gradual decrease in demand for US treasuries (thus creating a fiscal crisis scenario) or discontinuation of the Fed’s mandate to control money supply in preference for a tighter control on price (another way of saying currency war) the pendulum will have to swing and it is only in such a scenario that gold will have its heyday.
Thankfully for the bullion holders this might not be too far off. Thanks to the insistence of the US government to weaponise the US dollar or the gradual decrease in Treasury holdings by the Chinese this process is being helped in no small part by the Trump administration. The absolute debasement of G7 currencies also ensures that there is no credible alternative (Bitcoin and Libra notwithstanding?)
Not yet time to buy, if we’re wrong there are always pullbacks to buy in, if you wanted to be truly long you should’ve bought at 1100’s. Think of it like a 4 step process -
By the way, if you’d bought at 1100 -1150 USD, good call keep it on the side and forget about it.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.