Opposing Forces Confine GoldJoe Foster, Portfolio Manager, Gold StrategyAugust 10, 2021
Gold spent most of July range-bound at around the $1,800 per ounce level as opposing forces pulled gold in opposite directions. Gold was held back by a U.S. dollar that has been surging since the June 16 Federal Open Market Committee (FOMC) announcement in which the U.S. Federal Reserve (Fed) indicated it might begin tightening sooner than the market had expected. At the same time, gold found support from falling interest rates, as the ten-year treasury yield declined from 1.47% to 1.22% in July. Gold finished the month at $1,814.19 per ounce, for a $44.08 (2.5%) gain. The NYSE Arca Gold Miners Index1 gained 3.1%, as the larger producers trended higher with the gold price. However, the MVIS Global Junior Gold Miners Index2 declined 1.6%. The smaller companies tend to underperform in weak gold markets. Gold has been in a correction since it reached its all-time high in August 2020 and we expect the junior stocks to struggle until gold shows more positive momentum.
The World Gold Council’s second quarter report showed that overall demand improved in the first half (although not to pre-pandemic levels), mainly due to the resurgence of Covid in India. This was expected but what was a significantly positive surprise was the level of central bank demand. Central bank net purchases totaled 333 tonnes in the first half, which is in line with elevated levels of net purchases seen before the pandemic when Russia and China were the heavy buyers.3 This year, both of those countries have refrained from buying, while Thailand, Hungary and Brazil have stepped in as the largest purchasers. Thailand’s central bank governor indicated that gold addresses the key reserve management objectives of security, return, diversification and tail-risk hedging.4
Falling rates indicates the bond markets fear economic weakness ahead, whereas U.S. dollar strength is indicative of a healthy economy that is attracting investment flows. These diverging markets suggest high levels of uncertainty. The bond markets reflect anxiety over the growing impact of the Delta variant and concerns that the economy might suffer if the Fed begins withdrawing its stimulus. On the other hand, the dollar’s strength suggests rates will climb eventually as the economy improves.
It might be that that the dollar is correctly forecasting the near-term, whereas bonds are taking a longer-term view. Fiscal and monetary stimulus are set to drive the economy for another year or two, regardless of any problems caused by the coronavirus. However, we believe economic growth will face increasing risks once the stimulus begins to wane. The stock and debt markets may face collapse without the government-manufactured liquidity they have come to rely on.
Also, inflation is currently being driven by supply constraints as well as demand from economies emerging from the pandemic. The markets generally believe the Fed’s view that this inflation is transitory. However, we believe that record money supply, structurally higher commodities prices, shifts in labor-related demographics and on-shoring of trade means that inflation may persist in the long-term. A recent Wall Street Journal article focuses on supermarkets that are stockpiling inventory to protect margins from anticipated price increases later in the year. This is classic hoarding behavior used in the seventies to cope with inflation that compounds the problem. Consumers may adopt similar strategies. Inflation presents a significant risk, and if the bond market is correctly forecasting economic weakness, then perhaps the current inflation will eventually transition to stagflation.
Another interpretation of the divergence between the dollar and bond markets is that the traditional economic signals that the market relies on have been distorted by the radical fiscal and monetary policies that began with the global financial crisis and were unleashed on steroids with the pandemic crisis. The world is saturated with liquidity that is available at near-zero rates. Trillions of dollars can drive markets without regard to fundamentals when investors are desperate for returns.
Democratic free markets have provided benefits to society in health, wealth, education and freedom for over 200 years. No other system of government comes close to these accomplishments, in our view. The high levels of uncertainty about the future of the economy, and the often unorthodox or anti-market policies being adopted to cope with that uncertainty, we believe, are putting continued societal benefits at risk. Here are a collection of quotes that articulate our concerns:
- “Capitalism succeeds not because it is based on greed, but because the freedom to trade and do business with others is in harmony with our God-given nature.” Arthur Brooks, Professor of the Practice of Public Leadership, Harvard Kennedy School and Professor of Management Practice, Harvard Business School, in 2015.
- “In the private sector, we often have to remind ourselves to celebrate success because competition forces us to focus on solving problems and striving for continuous improvement.” Ron Johnson, U.S. Senator for Wisconsin, in 2021.
- “Easy credit feeds our love of immediate gratification, distorts self-regulation and diminishes prudent market behavior, creating a destabilizing positive-feedback loop.” Peter C. Whybrow, English psychiatrist, Award-winning author, and Distinguished Professor in the Department of Psychiatry and Biobehavioral Sciences at UCLA, in 2015.
- “It’s fair to say that $12.3 trillion of stimulus seems to have killed off the U.S. credit default cycle. Almost all fear of bankruptcy has been obliterated from debt markets” Lisa Abramowicz, Journalist on Bloomberg Radio and Television, in 2021.
- “Capitalism doesn’t work unless capital costs something and markets don’t work unless they’re allowed to rise and fall.” Sheila Bair, Former Chair of the U.S. Federal Deposit Insurance Corporation, in 2021.
- “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.” Ernest Hemingway in 1935.
- “Overall, the U.S. economy seems likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy’s underlying trend.” Ben Bernanke, American economist at the Brookings Institution and former Chair of the Federal Reserve, in 2007.
- “Inflation has increased notably and will likely remain elevated in coming months before moderating.” Jerome Powell, Chair of the Federal Reserve, in 2021.
- “Information is too voluminous, diffuse, and dynamic for central authorities to plan the economy successfully. Even the world’s smartest people and most competent governments don’t possess enough knowledge to micromanage sprawling complex systems. Instead, a diversity of opinions – in science, business and policy – helps us correct errors and climb the ladder of progress and truth.” Brett Swanson’s 2021 synopsis of Friedrich Hayek’s 1974 Nobel Prize Lecture.
- “I’ve spent my career talking about ‘why would you want to own gold?’ It has no income, it costs to store. And yet, when you see the debasement of the currency, you say, what am I going to hold on to?” Sam Zell, Founder and Chairman of Equity Group Investments, in 2021.
We have deep concerns regarding the risks that unconventional fiscal and monetary policies pose to free markets and capitalism. These policies have created excessive debt, ballooning money supply, asset bubbles, inflation, risky investment behavior, and elevated levels of uncertainty. In addition, well intentioned policies and regulations to promote social justice or climate control also risk unintended consequences that might undermine business and society. While we find these witty and concise quotes from economists, writers, and investors who share our view enlightening, investors should take these seriously and consider gold, an asset class with a recognized track record of offsetting pervasive market risk.
All company, sector, and sub-industry weightings as of July 31, 2021 unless otherwise noted.
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1NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold. 2MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver. 3,4World Gold Council, Gold Demand Trends Report, Q2 2021.
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