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Last year was a great time to be long gold. Low interest rates and debasement of fiat currencies, including the dollar, combined to send the SPDR Gold Shares (NYSEARCA:GLD) – the world's largest gold-backed exchange traded fund – to a 2020 gain of 20.8%.
In other words, an ETF designed to track a supposedly less risky asset topped the low risk ICE US Treasury 20+ Year Index by more 660 basis points and the S&P 500 by 640 basis points. These days, however, life is coming at gold fast. GLD is down almost 10.8% year-to-date – a 10% decline is the definition of a correction. Additionally, the benchmark gold ETF is, as of March 5, 18.16% below its 52-week high. That's almost a bear market.
Statistics like those coupled with the recent spike in Treasury yields underscore why gold is unlikely atop clients' lists of conversation starters, but advisors shouldn't be hasty in dismissing the yellow metal. In fact, there are reasons to view recent gold weakness as a buying opportunity.
“Investors should concentrate on the risk of monetary led inflation (originating from dovish policies and higher liquidity) leading to US dollar (USD) weakness – and the potential benefits gold could offer in that environment,” says Maxwell Gold, head of gold strategy for State Street Global Advisors.
Inflation, Reflation All Good for Gold
Some gold critics – Warren Buffett for one – say gold lacks intrinsic value. Fortunately, bullion possesses monetary value and it's historically a favored inflation hedge.
That's worth considering in the current environment because while inflation isn't at “runaway” status just yet, yields on Treasury inflation-protected securities (TIPS) recently turned positive and it's getting harder to ignore the fact that rising consumer prices are fast becoming an issue for advisors to navigate on clients behalves.
Think of it as an example circular reasoning. The dollar and inflation forecasts usually move in opposite directions and when the former is low, that's usually helpful to dollar-denominated commodities, including bullion.
“The inverse relationship between the USD and US inflation expectations tracks closely over time,” notes State Street's Gold. “This stems from the fact that a weaker dollar is inherently an inflationary action because it reduces purchasing power of US consumers, investors, and debtholders.”
Currently, the U.S. is employing monetary and fiscal policies that are “dollar hostile” with the aim being a weaker greenback will act as debt reducer and fan the flames of post-pandemic economic recovery. Keep in mind that a $1.9 trillion stimulus package is close to passage.
“Furthermore, fiscal stimulus tends to weaken a currency’s medium-term outlook. The prospect of more US deficit spending to combat the economic effects of COVID-19 and fund other domestic priorities such as infrastructure keeps the medium-term outlook muted for the USD, but potentially supportive of gold,” adds Gold.
Considering Correlations
While gold is said to be an inflation-fighting asset, it's long-term correlation to the consumer price index (CPI) is just 0.58. Advisors looking for higher levels of CPI sensitivity may want to evaluate broader baskets of commodities, listed infrastructure and real estate investment trusts (REITs).
Still, there is a correlation point in favor of gold: It's not intimately tied to the 60/40 portfolios advisors often favor.
“Gold has maintained a lower correlation to the diversified global 60/40 portfolio. While other real assets may offer higher inflation sensitivity to CPI, this comes at a cost of higher equity correlations and exposure to equity risk factors,” says State Street's Gold. “Gold’s lower correlation to diversified stock/bond portfolios indicates the potential for diversification without a drop off in sensitivity to changes in CPI over time.”
Add up the various factors mentioned here with the rapidly evolving 2021 landscape and gold with its low correlations and portfolio diversification properties is worth discussing with clients, even in modest allocations.
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