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“Gold is not everything, but everything needs gold.” – Russian Proverb
As of this writing, the Government Shutdown is entering its fifth week. Government employees are not getting paid, while many of them are still expected to show up at work, and SNAP benefits have been initially suspended but court rulings may restart partial payments. With things like this, that can change in a day, it’s really hard to write an article I need to get compliance approved and normally is published at least a week after I put the final edits to it. Obviously, if the shut down persists it will start to affect the economy; besides the mess that travel has become with Thanksgiving right around the corner. There are over 2 million Federal Employees who are going to start watching what they spend, as well as the 40 million-ish SNAP beneficiaries, not to mention contractors and businesses that are owed money from the Government. For good or ill, the Federal Government makes up 20-25% of GDP depending on the year so a pullback of that much spending obviously puts us in a recession. But that’s only if the money never ends up getting put back into the economy and typically when these things end, they catch up on all the past spending. So, the jury is still out on the economic consequences of the shut-down and the political consequences are for a different person’s newsletter. Given that, I’d like to talk about something more tangible, Gold.
What is gold trying to tell us? Since the first of the year, the price of gold is up just about 50% (as of this writing.) That’s a huge move in a commodity that barely averaged a 2% annual return for the first 40 years of my life. The price appreciation really accelerated in October, peaking at about $4,300 an ounce before pulling back somewhat, but it had been going up all year. Stock market goes up, gold goes up. Stock market goes down; gold goes up. Fed is going to cut rates, gold goes up. Fed might not cut rates, gold goes up. Good inflation report, gold goes up. Bad inflation report, gold goes up. Clearly there’s a message here, or maybe several. Let’s discuss the boring technical reasons for this rise and then progress to the more troubling, bad things are on the horizon reasons.
On the no big deal front, our current administration is not playing nicely with other governments around the world. We’ve imposed tariffs which in many cases violate trade agreements we’ve made with those countries or with larger trade blocks like the EU. This theoretically should lead to less trade, meaning countries have less need to hold U.S. dollars, selling those dollars drops the value of the dollar against other currencies and also against internationally traded commodities like gold. While as mentioned the price of gold is up over 50% in U.S. dollars, it’s up about 20% less in Euros. If this fall in the dollar was the whole reason for gold’s spike this would be a short article, but gold is still up sharply in other currencies so clearly something more is at hand.
A second reason is related to the first. Many foreign countries buy U.S. Treasuries not just to smooth out their currency value for trading, but as an actual safe haven for their national savings. Traditionally U.S. Bonds have been seen as the safest investment out there, or at least the safest you can buy in multi-billion-dollar increments. Some of these foreign countries have shifted a small amount of that bond buying, to buying gold. Nobody knows for sure the value of all the gold in the world, but even the high estimates put that value below that of all the U.S. treasury bonds outstanding, but that’s not the whole story. Only a fraction of the world’s gold actually trades on a day-to-day basis. Most gold is in your jewelry box, on your finger, in a museum or in a vault at a military base in Kentucky. On the average day over $900 Billion of Treasury Bonds trade hands, even in the last few weeks with the price of gold going crazy, the average trading volume is only about $1.6 Billion in gold. It doesn’t take much of a shift from bonds to gold to move the price significantly. It’s impossible to know exactly how much the current gold price movement is due to this factor, but my educated guess is that the 30% or so run up in the price from January 1 to about two months ago was primarily related to this shift. The last couple of months seems to have a different feeling.
The last reason for gold to have this type of performance, is people are really, really worried about the economy, not just in the U.S. but around the world. The tariffs are completely changing how the world trades and how countries relate to each other. The recent tax bill continues to explode the U.S. National Debt (the tariff revenue is a rounding error) and nobody seems to have a plan to do anything about it. To circle back to world trade, there was always a mantra that countries that trade with one another don’t shoot at one another. Now this is simplistic and not exactly true, but the less dependent two economies are on each other, the less that stands in the way of open antagonism. That doesn’t have to mean an out and out war, but how much of China’s hands off policy toward Taiwan was based on not wanting to test the very beneficial trade relationship it has with the United States and Western Europe? How much influence can the United States have in calming tensions between India and Pakistan over the Kashmir region, if India’s economy relies less on its relationship with the U.S.? Back to domestic economics, now that the Fed seems dead set on lowering rates, what happens if inflation starts to come back, as evidence suggests? I’m not one to say, “This time is different, more dangerous, more troubling.” But the price of gold is certainly saying that. The only logical explanation for this parabolic spike in the price of gold over the last few weeks is simply anxiety. Gold is a safe haven when the world goes mad, and a lot of people are apparently worried about that very thing. While we have gold in our portfolios and have thus benefited from this appreciation, I would trade $1,000 in the price for a little more world stability, I’m sure you all would too.
The last time gold spiked like this was in the late 70’s / early 80’s when interest rates and inflation were running wild and the U.S. economy had been in the doldrums for six or seven consecutive years. Those gold buyers were wrong. The inflation spiral was about to end, and the stagnant economic growth was just about to turn around. So, while a buying spree in gold can mean a lot of people out there are worried, it doesn’t make them right. Nobody knows what the future will bring. So those of you in our managed portfolios enjoy the additional return that gold holding has brought you, but don’t feed into the frenzy and end up having too large a concentration in one commodity. History has shown us that doomsayers are very rarely correct. It’s not as if gold has been going up at the expense of everything else, it’s been a pretty good year all around the markets, stocks, bonds etc. As always, if you want to talk about it, give me a call. Have a wonderful Thanksgiving.
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