Regular readers know we’re not big fans of gold outside of the hedging benefits it can provide in a portfolio.
The fact is, it’s just a piece of metal. It has no intrinsic value and ironically, it will be even more inherently worthless in an armageddon scenario than it is now.
As we’re fond of putting it, the only thing gold will be good for if we all find ourselves living out Cormac McCarthy’s The Road is as a weapon to bludgeon the cannibals with when you run out of bullets. You can’t burn gold for fuel and you can’t eat gold, so I’m not sure why anyone thinks they need a personal safe full of it to guard against the nuclear apocalypse.
With that out of the way, obviously it can serve a purpose in the portfolio context and given the very real possibility that there’s an acute, indiscriminate risk-off episode in everyone’s future that might not be tied to the Fed (i.e. a risk-off episode that doesn’t result from some hawkish lean somewhere and thus isn’t accompanied by rising real rates), it’s probably worth considering whether allocating more to carefully polished yellow doorstops would be a prudent move.
We’re not going to spend a ton of time on this because frankly we don’t find it very interesting (if you want to own some pretty paperweights, well then by all means stock up, we don’t give a shit), but it’s worth noting that Goldman is out with something new. We’ll just hit the high points. They start by noting the decoupling with real rates:
Before reviewing the basic tenants of the investment thesis (the first bullet point is just all the obvious shit, while the second is a recap of the “3Rs” – more on that here). To wit:
- In its “Fear and Wealth” gold forecasting framework, fear is the key medium- to short-run driver, encompassing the relationships between gold and real interest rates, debasement risks, sovereign balance sheet risks, geopolitical risks and other market tail-risks. Stated more simply, this is risk-on/risk-off behaviour in markets. Wealth is the key long-term driver, and is most relevant when considering EM economies. As economies grow, household savings are allocated towards gold at a roughly fixed rate – creating a link between GDP growth and the equilibrium level of real gold prices.
- The 3Rs are short-hand for describing the current growth backdrop and how it relates to commodities. In it, we see strong demand growth against limited commodity supply growth creating significant reflation pressures. We also see higher commodity prices reducing the number of bad loans on producers’ balance sheets and freeing up capacity on bank balance sheets, leading to more credit extension in EMs and a broad releveraging trend. More EM leverage could lead to more growth, and reconvergence with DMs. Ultimately, this synchronized growth would drive more reflation pressure – closing the loop and making the cycle self-reinforcing. With the 3Rs in full swing since late 2017, we believe we are currently seeing stronger (reconverging) EM growth, which in turn has been helping to drive a normalization in EM incomes (particularly for commodity-producing economies), a higher level of savings and hence a rising equilibrium gold price as EM gold demand recovers from previous lows.
Ok, so what if you don’t care about any of that? That is, what if you’re just interested in holding gold as a hedge against the possibility that a certain “very stable genius” is impeached or else does something so egregious on the foreign policy front that everyone runs for cover?
Well if that’s you, Goldman has some basic “gold in an equity selloff” factoids that might be useful as a reference guide.
“Exhibits 6 and 7 demonstrate that for the first 30-40 days of an equity sell-off, the average gold response has tended to be quite small [but] after this, we tend to see a stronger hedging response, and by the time the typical equity market hits its trough, gold is up over 7.5% on average,” the bank writes, before summarizing that as follows: “In summary, it can take time for gold to start to act like a hedge, but when it finally does, it has functioned well.”
What’s with the delay? Well probably the fact that people aren’t inclined to effectively sequester their money away in hunks of metal until they’re sure that whatever caused the correction is actually systemic as opposed to technical and/or fleeting.
Finally, if you’re worried about real rates or about the prospect of gold during a tightening cycle, Goldman thinks maybe it should be fine. Here’s why:
The 10Y nominal rates are currently around 2.9%, much closer to our interest rate strategists’ forecasts for 3.25% by end-2018. This is more than 50bps higher than in October 2017, but the increase has not been strongly noticeable in the gold market. Once again, our commodities team thinks this has been the 3Rs at work – specifically reflation, and in particular higher oil prices, has taken inflation break-evens almost 30 bps higher, leaving 10Y real rates with less than 20bps of upward adjustment. Given that GS continues to expect this hiking cycle to be characterised by a measured pace of Fed tightening, inflation break-evens could still rise a little further before becoming a worry. Further, with EM savings and wealth backdrop supportive of gold demand, our team now sees much less downside risk from monetary policy normalisation compared to just a few months ago.
And look, if all of that isn’t enough to give you some confirmation bias when it comes to your propensity to be enamored with yellow rocks, then just ask the guy in the picture below. He’ll be happy to tell you all about how “tremendous” gold is…