NEW YORK, NY – Over 20 years I have strongly advocated that investors must have a stake in gold. But I am not, and never have been, what Wall Streeters call a “gold bug.” Gold bugs believe in gold as a doomsday investment. They are fervently pro-gold at all times because they fervently believe at all times that apocalyptic disaster lies just around the corner.
Gold bugs do have one part of the picture right: Gold is the best investment during times of turmoil and contracting economies. That explains why it has been so strong in the past couple of months as the Covid-19 pandemic has wreaked havoc. But gold also is the best investment during very different sorts of economies, during times of rapid growth when commodities like oil are rapidly rising in price and threatening to become scarce.
Why should gold flourish under such seemingly opposite conditions? The mantra I’ve coined to explain it is “gold or Goldilocks.”
Goldilocks, you recall, was the little girl in the story who stumbled upon the home of the three bears while they were out for a walk. Sampling their wares, she rejected the porridge of the Mama Bear as too cold; the porridge of the Papa Bear as too hot; but declared that the porridge of the Baby Bear as “just right.” For economists, Goldilocks economies are those that are neither too hot (inflationary) or too cold (deflationary) but just right. More precisely, they are periods of sustainable growth.
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Goldilocks economies are terrible for gold. When economic growth is sustainable, investors focus on buying stocks, because the conditions make it possible for companies to keep profit growth rising. The 1990s were a notable example of a largely Goldilocks economy.
But when Goldilocks is nowhere to be found, that’s when gold shines, outperforming stocks and other assets as well. That’s true over both short and long time periods, and it applies to two very different kinds of non-Goldilocks economies. One is deflationary times, when economic growth is negative. The other is when there is growth – when GDP is rising – but there is reason to think it isn’t unsustainable, that growth will short-circuit.
What are the signs that growth won’t be sustainable? You need to look at commodity prices. If they are rising faster than GDP is growing, it implies big problems for the economy lie ahead. That’s because rapid rises in commodities undercut growth. The rising prices – and most notably rising oil prices, which not only mean higher prices at the pump but raise the costs of producing pretty much anything – take money out of consumers’ pockets and put pressure on profit margins of companies.
Gold’s performance this century reflects these relationships and offers a guide to the future. In the past few months, in the turmoil engendered by Covid-19, gold’s performance has stood out as stocks have crashed. From the start of February through mid-April, gold is up more than 9% compared to the S&P 500’s drop of 14.25% – a differential of nearly 25 percentage points in gold’s favor.
That recent strength in the face of a plunging stock market has gotten attention. But gold’s longer-term out-performance in the past two decades has passed largely under most investors’ radar. For most people, all the focus was on the surging Dow and S&P 500. And it’s true that stock markets were reaching giddy heights. But were they doing better than gold? Not by a long shot.
Here are some numbers. On December 31, 1999, gold traded at around $288 an ounce. On January 31, 2020, it was about $1,600 an ounce – some 5.6 times higher.
During that time, the S&P 500 rose 2.1 times – underperforming gold by more than 60%. With dividends reinvested, total returns from the S&P 500 were more than 50% above the nominal gains but still 40% below the gains from holding gold.
If gold handily outperformed the S&P 500, how did it do against other assets – real estate, for example? The mostly widely followed real estate indexes were developed by Karl Case and Robert Shiller and track resale prices of single-family homes. The most recent value of the broadest Case-Shiller index is 212.43 compared to 99.58 at the beginning of the century. That’s a rise of 2.13 times, about the same as for the S&P 500 excluding dividends and more than 60% below the gain in gold.
Cash and bonds also sharply underperformed gold. The most widely followed benchmark for bonds is the Bloomberg Barclays U.S. Aggregate Bond Index. It measures total returns from a full spectrum of corporate and government investment-grade bonds. The index rose from 833.75 at the century’s start to 2,314 at the end of January 2020. That ratio of 2.7 is a little lower than the gains in total returns of the S&P 500 and more than 50% lower than gold’s gains.
In sum, gold has been this century’s unrivaled star. It marks the longest period in modern history in which the metal has outperformed all other major assets including stocks. (The second-longest was the period between the beginning of 1929 and the end of 1945. Gold also outperformed in the period between 1970 and the early 1980s.)
Gold’s performance this century, both overall and in shorter-term periods, matches up essentially flawlessly with my “gold or Goldilocks” mantra. During the first 11 years of this century, commodity prices sharply outpaced economic growth and gold sharply outpaced the stock market. Between 2011 and the end of 2015, stocks rose while commodities faltered and gold corrected. Between 2016 and 2019, gold was strong during those relatively brief stretches when commodities were rising faster than GDP; at other stretches within those four years, the reverse was true. Overall this century through January 2020, commodities outperformed growth by 45% – an annualized rate of 2.9% vs. 2%. And clearly our mantra applies so far this year as negative growth has marched hand in hand with rising gold.
I have consistently urged subscribers to my investment letter The Complete Investor and in other writings to own gold, both as a hedge against any outbreak of deflationary turmoil and as an asset that will soar during periods of commodity-driven inflation. (When I say own gold, I don’t necessarily mean buying the physical stuff, though that’s a fine option for anyone who wants to take on the added complications of buying physical gold, storing it, insuring it, and so on. Instead I’ve been recommending a few ETFs that track gold and gold miners, plus a handful of selected gold miners.)
But the sad news is that even as gold has been the big winner this century, most Americans haven’t participated (or likely even are aware of it). Only a minuscule portion of Americans own gold. Each quarter the Federal Reserve publishes estimates of the balance sheets of American households. The two most important assets are stocks and real estate (mostly homes). Bonds and bank deposits are also important. There is no separate entry for gold. Possibly it is lumped in with durable goods, a category that is small relative to stocks and real estate; within this small category, gold would be a relatively minor constituent, with autos far more important. Most estimates are that between 1% and 5% of Americans own gold as an investment.
I hope that changes, because I see almost no possibility that we’ll see another Goldilocks economy anytime soon. Over the more immediate time frame, it seems a good bet that it will take time for growth in the U.S. and globally to get back on track. That makes gold essential as a deflationary hedge, the role it has played so well in recent months.
Once economies start to recover, commodities may remain under pressure initially and gold may pull back for a time. But given all the massive economic stimulus, which will almost certainly have an effect on the commodity-hungry developing world, I think that the likeliest outlook is that ultimately strong gains in commodities will follow, propelling gold far higher over the longer term. The almost certain non-appearance of Goldilocks in coming years makes gold an essential investment for investors of all stripes.