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The Case for Gold (Part 1)

May 29, 2020

Gold is one of the champion assets so far this year.

Gold in the spot market is up by 13% year to date. That’s a lot better than the S&P 500 Index, which is still down 5.1%.

Even the overall US bond market is only up 5.2%.

Spot Gold June 25, 2019 to Date—Source: Bloomberg Finance, L.P.

I got on board with the gold market back on June 25, 2019. That’s when, for the first time ever in my professional career as a newsletter editor, I made the recommendation for a particular gold play.

I always viewed gold as an odd investment. It doesn’t generate yield in most market forms, so there is a cost to hold it. And I never viewed it as a form of currency, since you can’t really spend it without taxable events under IRS rules.

What changed my mind about the Midas Metal?

Two specific developments: Low US interest rates and a US dollar that was under control and not set to soar.

Gold is priced in US dollars, so a rising dollar in a static gold market means that the price for gold falls. And conversely, a falling dollar makes gold more valuable. Even if the dollar is neutral, it wouldn’t provide a headwind for gold.

But short-term interest rates are the real driver for gold prices.

Holding gold has two primary costs—storage and opportunity costs. Let me leave storage aside for a moment and focus on opportunity/finance cost.

Since gold doesn’t pay a yield, there’s the cost of lost interest given up each day that gold is held. And for many institutional gold investors, they’ll also finance gold, so interest rates directly impact the cost of holding gold.

The lower the interest rates, the better gold will fare. You see this in the graph that shows the one-month US Treasury yield and the spot gold price from June 2019 to date. There is and has been an inverse relationship between gold and interest rates.

Spot Gold (Gold) & One-Month US Treasury Yield (White)—Source: Bloomberg Finance, L.P.

Last June, I saw rates heading lower, lower inflation and changes in the Federal Reserve’s monetary policy.

The core Personal Consumption Expenditure (PCE) index was below the Fed’s target rate of 2.00%, and it was slipping. The Fed began to reverse its tight monetary policy tack, which began to move short-term US rates lower.

The Fed kept easing, including interventions in the credit markets last year. And of course, the Fed is all-in this year, driving rates ever closer to zero. PCE will remain low for the foreseeable future, and the Fed is going to work like the dickens to keep rates on the floor.

This is all great news for gold.

Outside the US, interest rates and bond yields are in negative territory. That means banks are charging for deposits, and bond buyers are accepting built-in costs to buy and own bonds.

The overall amount of negative yielding debt in US dollar terms has surged just since March from $7.7 trillion to $12.1 trillion. That makes gold all the more attractive to store value, since outside US bonds, foreign deposits and government bonds have negative yields.

Global Sum of Negative Yielding Debt in US Dollar Terms—Source: Bloomberg Finance, L.P.

Furthermore, the US dollar is continuing to come off recent highs following the surge in demand during the market chaos in March. The Bloomberg US Dollar Index has been dropping and trending lower, making gold all the better in US dollar terms.

Low to lower US interest rates, negative yield and interest rates outside the US and a benign to lower US dollar have been and will keep driving gold higher.

I’ve got much, much more to say on this topic, including the gold play that my Profitable Investing subscribers have been enjoying since last June.

Here’s a hint: It’s not the SPDR Gold Shares ETF (GLD).

Stay tuned for Part 2 next week…

All My Best,

Neil George
Editor, Income Investor’s Digest & Profitable Investing
Author, Income for Life

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