Why buy Gold and Why Now?

Dear Mr. Market:download

We have commented many times on how people have short memories. In the case of recent stock market behavior, however, there is no way one could forget what a ride we’ve all been on. Our job today is not to draw attention to the very obvious past but to one area of the market that is not always directly connected to stocks or bonds.

Do you have gold in your portfolio and if so, should you buy more, hold on to what you have, or dump it?

Let’s first review some quick stock market math that most people never really grasp. If you start with $100 and the market drops -40% you clearly have $60, correct? Now if we see a rally like we recently have of +25% would you now have $85 and only be down about -15% from the peak?

Nope.

The +25% rebound is off of $60 (not $100) so that gain is only $15 which leaves you at $75 (and still down -25% from the starting point). It won’t help your frame of mind or strategy to rehash the pain, lament, or add vinegar to the wounds of the market, but what we can do is discuss options going forward.

We don’t want to rain on the recent parade and of course welcome a recovery of any sort. Shop talk aside…like all people we simply would just like to see the world we once knew a few months ago come back to normal. What concerns us about this recent rally is that it seems to be a little ahead of itself and fundamentals in general. Yes… there is, and perhaps will be more, immense pent up demand for when the economy is finally unhitched. In our opinion, however, what we’re seeing now is a little gas thrown onto a struggling fire. The Fed didn’t just shoot a few bullets at the economic problem but rather a bazooka. That said, never in history has there been a free lunch. It’s not a question of if but rather when we will see the ripple effects of spending trillions of dollars to help us through this unprecedented crisis.

Before we dig into the merits of owning a shiny object (gold), allow us to quickly recap what the market has done and where it might go (not with necessarily why or give you more news on COVID-19 as we’re all a bit “Corona’d” out lately). Many pundits will argue that we hit a market bottom in late March and that capitulation was reached. We wrote about that possibility a week before the recent market low right here. Could this market retest lows? Also, is this recent rally a V, U, or L-shaped recovery? While we do think the stock market will be higher in five years, the way it gets there could be very uncomfortable.

Past Market Crashes with Recovery Overlay

The chart above overlays four past stock market crashes compared to our current one. As you’ll note the recent “recovery” and bounce back (in red) is behaving in similar fashion to several before. This inexact science may bode well if we end up like 1987 which actually¬† finished the year positive. The flip side to this illustration is what if it doesn’t? It’s not difficult to see two of the four retested lows and really broke down further. So why gold now?

Full disclosure…Historically we have not been big fans of gold. It’s a non performing asset that has zero ability to improve itself like a company and its leadership can. Gold has zero earnings or dividends. Many people also mistakenly regurgitate that it’s inversely correlated to stocks providing an almost perfect hedge. This too is false as we can make any chart tell a story that fits a certain narrative. In general though, it can provide some hedge to the risks and volatility of the market. The chart below shows well for gold but whoever put it together left out one little detail …dividends! We’ll save that discussion for another day but when you add in dividends, and not just the price levels of the stock market, the picture becomes quite different.

Gold vs Stocks Long-term

Our main point today, however, is not what gold has done or which doomsayer is pitching it to sell their newest book; we’d like to point out that there is a decent case to own more of it in the foreseeable future. As of this writing gold has run up about +12% YTD compared to the stock market being down -10% over that same stretch. A stock market fan would say “well how about the past few years before the crash?”…The net three year number still have gold beating the market roughly +34% to +29% respectively. All that said, we don’t think it’s done!

Even though gold has already had a nice run, we believe we’re in the earlier stages of a longer bull market cycle. With recent monetary expansion, historically low interest rates, massive debt and potential inflation on the horizon…we think gold could be much higher in the next couple years. While we often mock predictions and those who pretend to own crystal balls, we’ll put something to shoot for and have this serve as another time stamp. On one hand we think it’s a bit extreme to join the crowd that thinks $5,000/ounce gold is coming, however to see it climb higher from it’s current level of about $1,694 to $1,975 in 2021 is not out of the question at all and could easily happen.

Inflation has been dormant the past few years but that is going to change. We’re not predicting hyper inflation but inflation at even a 3% growth clip, coupled with interest rates that are unlikely to rise soon… you’re going to see greater demand for investments like gold. While “cash is king” during any crisis, we’ll eventually get through this and people will see that cash, treasuries and CDs are losing propositions due to the silent killer of inflation. We also don’t think the government is finished throwing money at our problems. Mix in another catalyst of a weakening dollar and there is plenty of reason to believe gold could move substantially higher.

Lastly, be on the lookout for a follow-up piece to this article that centers not so much around gold but rather the rest of our proposed allocations in this unique environment. Historically most of our models never allocated more than 5% to gold but in some portfolios we are north of 10% right now with plans to increase to 12%. Next week we’ll share exactly what we are getting rid of in a theme of “less is more”…Stay tuned!

 

 

 

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