“All that glitters is not gold” is a phrase made popular by Shakespeare in his play The Merchant of Venice. It means that not everything you think is valuable, beautiful and desirable will reflect its actual worth – that sometimes the things that look the most pleasing and beautiful are the ones that lack true quality and value. It also implies that gold inherently does have true value, and it is something worth possessing. Just ask King Midas!
If you watch television much, you’ll hear advertisements telling you how gold will protect you against inflation, and how gold is and will be a great investment in times of financial stress and war. Yes, sometimes that is true, but lately it has not worked very well. As everybody know who occasionally fills up their car with gas to go to the supermarket, inflation is running rampant. Just this past Thursday, the core CPI, which excludes food and energy, was up 6.6%, the highest level in forty years. So how has gold protected investors this year in this time of great inflation? Not very well. It reached a high on March 8 at $2,091.40 per ounce, only to fall to a low of $1,622.20 on September 28. That is a decline of 22.4%.
Take a look at the chart below. It compares the CPI and gold dating back to 1970, the year I began my career as a commodity broker and analyst. The shaded grey areas are periods of economic recession.
Generally speaking, there we times when gold prices skyrocketed, as it did in the inflationary period of the late’70s. There were also times when gold price rallied sharply in response to great economic turmoil, as it did during the aftermath of the 2008 economic crash. In contrast, there was a long period where owning gold was a losing proposition. Anybody who owned gold from roughly 1980 to 2005 enjoyed virtually no price appreciation and suffered the indignity of paying storage to hold the gold, and furthermore lost out on the opportunity to earn any interest on their money. Most recently, gold prices have declined in a time of high inflation.
More specifically, we commissioned a study showing the performance of gold dating from 1972, shortly after President Nixon took the United States off the gold standard and let the price float. The good news is that if you would have bought gold back then and held it until now, you would have enjoyed a compounded annual rate of return of 7.55%. The very bad news is that during the same time period, you would have suffered horrendous losses. From the high of 1980 to the low of July, 1999, you would have lost 69% of your investment, and that is not counting the value lost due to the inflation of that period.
What’s next? We believe that the Federal Reserve’s easy money policy for the past twenty-two years has greatly distorted and inflated financial and commodity markets. Now that the Fed has reversed course and tightened credit conditions, the opposite is taking place: stocks, bonds and commodities have all been pressured. Our gut feeling is that the Federal Reserve will keep short term rates higher than many expect, so it is hard for us to see how and why stocks, bonds and commodities can rally very far. Thus, we now have the seeming anomaly of gold prices declining in the face of higher inflation.
On the other hand, we think the United States has become more aggressive and antagonistic towards Russia and China, and we can’t rule out that either country will resort to greater military action. If so, how will President Biden respond? We hate to say it, but we are not very confident about the President’s possible response. Gold could do very well.
The bottom line? As seasoned commodity traders, we think it makes sense to own gold as part of an investor’s total investment portfolio, but that is not enough. Investors should own gold but diversify by trading other commodities along with gold. Also, make sure that your strategy allows you to go both long and short. As history shows, buying gold can make you a ton of money, but like stocks and bonds, you sure have to sit through some nasty periods of losses.
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