It's pop quiz time. Which of these three investing benchmarks produced the biggest returns since the summer of 1999 through the start of 2018: the S&P 500 average of large-cap stocks, China's Shanghai Stock Exchange composite index, or gold?
X The correct answer? That shiny metal used a lot in jewelry, traded heavily by short-term speculators in the futures markets, and stored for long-term safekeeping in bank vaults around the globe.
From a bottom near $250 a troy ounce in August 1999 through Wednesday, gold has delivered compound annual growth of 9.6%. Thanks to solid gains over the past year, the S&P has improved its annually compound gain to 4.5% in that nearly 18-1/2 year span, excluding dividends. And the Shanghai composite has gained a compounded 4.6%.
If you guessed wrong, it might be because a tough 5-1/2 years took some shine off gold. The price today is still off 29% from its all-time high of $1,895 an ounce in 2011.
But in recent months, gold is regaining its mojo.
On the Comex exchange, near-term futures are currently at $1,363 an ounce, rising 9.7% since its mid-December near-term low and up 4% since Jan. 1. That year-to-date advance still trails a 5.8% gain for the S&P 500 and a stunning 7.6% rise for the Shanghai composite.
Yet even as Bitcoin fever seems to be catching on, gold futures appear to be breaking through a key downtrend line that stretches back to September 2011.
A sharp upward bust of that trend line could signal a change in direction again and another long-term buying opportunity. For the SPDR Gold Shares (GLD), that inflection point would be a thrust above 123.
The highly liquid ETF on Wednesday gapped up to a 1.4% gain to 129.07 in heavy turnover. SPDR Gold is also clearing a 128.42 buy point in a nearly five-month saucer base.
The ETF trades on average 7.1 million shares a day; in other words, as much as $896 million worth of the popular trading vehicle changes hands each day. SPDR Gold Shares is now up 10.8% since Jan. 1, still ahead of the S&P 500's 6% advance.
Not that gold is an easy game to play, especially for short-term speculators. Gold prices continue to show tremendous volatility in the short term, vacillating with the latest political, economic and international tides. Since October of 2016, the London P.M. fixing price of gold has risen or fallen 2% or more for the week at least 14 times. And since July of last year, it moved up or down 1% for the week at least 18 times.
No wonder many golden hairs on commodities traders' heads quickly turn silver.
"Gold has no true fundamentals, no intrinsic value, only limited industrial and practical use and doesn't generate cash flow," said Sandra Navidi, CEO of the macroeconomic consulting firm Beyond Global LLC.
"Its value is primarily driven by fickle psychology and by what the next investor is willing to pay," said Navidi, the author of "$uperHubs: How the Financial Elite & Their Networks Rule Our World."
So, if you don't want to trade in the short term, how do you win in gold?
One key, says veteran portfolio manager Joe Wickwire, is to fully comprehend the difference between being a speculator and an investor. An investor thinks long-term (at least three to five years) and understands the beauty of gold as a hedge against the weakening purchase power of other financial assets.
Wickwire's job as an investment professional is to exploit the disconnect between the price of gold when it is driven by short-term speculative money and to know when it makes good sense as a long-term play amid changing financial, monetary and economic conditions.
"Gold is a financial asset insurance policy," said Wickwire, who has managed the Fidelity Select Gold Portfolio (FSAGX) mutual fund since August 2007 as well as the Fidelity Global Commodity Stock Fund (FFGCX). Wickwire keeps a chart on the wall of his office in Boston listing 17 factors that influence gold prices, adding "I could add another 17 factors."
The Fidelity Select Gold Portfolio fund is up 2.7% since Jan. 1 and up 8.6% over the past year.
Over the long haul, the four chief factors influencing gold prices are macroeconomic imbalances, geopolitical shocks, the laws of supply and demand, and the overall state of the gold mining industry, he says.
Wickwire shares a simple yet brilliant rule of thumb that can help an individual investor get a sense of the long-term picture for gold: Look at real interest rates. When rates are less than 2%, the price of gold tends to go up.
Right now, the fed funds rate on overnight bank loans is in a target range of 1.25%-1.5%. Many economists expect the Federal Reserve to raise interest rates by a quarter point three times this year, repeating what it did in 2017. Currently, the U.S. prime rate is 4.5%.
Compare those figures with the 1970s, when the U.S. economy suffered from double-digit unemployment and torrid inflation. By 1980, the yield on the 3-month U.S. Treasury bill climbed toward 14%, but the real rate after inflation was low. Gold and other precious metals were hot.
When Federal Reserve chief Paul Volcker set on a course to kill inflation by sharply raising short-term interest rates during the early years of Ronald Reagan's presidency, the market turned upside down. Inflation fell, economic growth came back, entrepreneurs started new companies as tax rates fell, and U.S. equities had their longest stretch of gains (1982 to 2000) of the century.
"Real rates came down and assets were priced properly. Gold was boring," Wickwire said.
Not so, lately.
Increasing military tensions in Russia, the Middle East and North Korea, plus a growing sense that the Fed won't be raising short-term interest rates quickly, have provided a sort of tail wind for gold. However, yields on the 10-year Treasury have recently surpassed a mid-March 2017 peak of 2.62%.
Gold Price Is Hard To Predict
Investors seeking a long-term view of gold must keep in mind that the correlation between gold and other major financial assets is not consistent.
In the 1990s, gold was a dead weight loss in portfolios as large-cap stocks reigned. From 1995 to 1999, the S&P 500 more than tripled while gold dove nearly 40% from a multiyear peak around $415 to the generational low of $252. Stocks and gold showed an inverse relationship.
That changed in the 2000s to early 2010s, when gold staged one of its most amazing rallies ever. The upturn coincided with a strong rally in stock prices from the end of 2002 to December 2007. China's voracious appetite for all metals boosted demand.
Just as important, if not more important, the Federal Reserve helped spur a devaluation of the dollar, making gold cheaper for overseas investors to buy. The weaker dollar also made institutional investors move into other assets.
From January 2001 to June 2003, then-Fed chair Alan Greenspan and crew slashed short-term interest rates 13 times, from 6% to 1%. Equities recovered. Gold began to soar.
"While the long-term correlations between U.S. stocks and Treasuries, and U.S. stocks and gold, are low or even negative ... the actual realized correlation between these assets oscillates between strong and weak over time," investment managers Adam Butler, Michael Philbrick and Rodrigo Gordillo wrote in the 2016 book "Adaptive Asset Allocation."
The monetary winds are blowing in a new direction today.
Since the end of 2015, the Fed has slowly tightened the money supply. Yet the U.S. dollar is reaching multiyear lows vs. the world's other major currencies.
Since the second half of 2011, the ICE futures market's U.S. dollar index had recovered two thirds of a 41% plunge (from 121 to 71) suffered from 2001 to 2008. This index tracks the dollar's strength against a trade-weighted geometric average of six currencies, including the euro, yen and pound.
However, ICE U.S. Dollar Index near-term futures are now at 89.03, taking out a September 2017 low of 90.87 and hitting the lowest levels since December 2014.
Other factors to keep in mind: An improving economy may boost consumer-led demand for gold, especially in the form of jewelry. And the rising middle classes in China, India, Russia and Africa may also drive demand. Yet gold doesn't pay dividends. Equities give the best economic exposure for investors who have confidence in corporations' ability to grow the top and bottom lines.
Are Gold Mining Stocks And ETFs Good Alternatives?
Many traders like to bet on gold mining companies and related ETFs. However, the risks of losing money in gold miners are higher than an ETF that simply tracks the price of gold bullion, such as GLD ETF. A gold mine could close due to worker strikes, bad weather or war. A mining firm may also place restrictive hedges on its selling prices, limiting its revenue upside if gold prices soar.
"Exploration, production and ancillary costs are high across the board," said Navidi, who worked several years as research director for Nouriel Roubini, the economist and NYU business school professor. "Generally, there is limited upside when the gold price rises, but great downside when the price falls. Most mining company investments in the last decade have disappointed."
The Direxion Daily Junior Gold Miners Bull 3X ETF (JNUG) amplifies the move of the Market Vectors Junior Gold Miners index by 300%. JNUG, currently around 20.28 following a reverse 1-for-4 split in May last year, remains 61% off its 52-week high of 52.12.
If you want to make money using such leveraged ETFs, your best option may be in limiting the use to day trades or short-swing moves.
How Will Macroeconomic Factors Affect Gold?
The U.S. economy isn't exactly going into hypergrowth mode now, but it is showing signs of acceleration. U.S. GDP rose just 1.2% in the first quarter of 2017, but then picked up to 2.6% in Q2 and 3.2% in Q3. A preliminary reading for fourth-quarter gross domestic product is expected on Jan. 26; the Econoday forecast calls for a 2.9% consensus gain, with estimates ranging from 2.2% to 3.3%.
Consumer prices are rising, but inflation is still relatively tame. In December, the U.S. consumer price index inched up 0.1% month on month and rose 2.1% vs. a year ago.
China has been steadily trimming its annual growth forecasts as it seeks to transform its economic model after decades of export-driven whirlwind growth. A slow yet steady rise of the economy may lower the chances of a severe economic freeze and a subsequent rush into gold.
Money managers will also be watching how quickly the Federal Reserve unwinds its $4.5 trillion balance sheet. As part of its so-called "QE 3" program, the Fed bought billions' worth of Treasury bonds and mortgage-backed securities for several years to help keep the cost of money at ultralow levels. That era is over. While the money supply is likely to tighten, the expected outflow from government bonds may lead to more money flowing into other assets, including gold.
"The gold price is going where real interest rates are going. The market had expected four to six interest rates, and that wasn't a long-term negative for gold," Wickwire said, noting that the market has now adjusted to the likelihood of fewer rate hikes. "This is where long-term investing comes into play."
(Editor's Note: A version of this column was first published in the April 24, 2017, edition of IBD Weekly. Follow Chung on Twitter for future observations on gold, interest rates, growth stocks, stock breakouts, and other financial markets at @IBD_DChung.)
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