Category Archives: Gold

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Are Safe Havens Really That Safe?


  • Economic laws can’t be muted forever, and in the end always get their due, therefore it is good to look at other options to de-risk your portfolio.
  • Gold is too volatile to be considered a safe haven.
  • Diversification should be the best option to avoid losing everything in a market downturn.

Introduction

Economics is pretty straightforward. The first thing they teach you in ECON 101 is that the economy works in credit cycles. In a positive environment with low risks and low base interest rates, people borrow and spend. They buy a new car, go on trips, refurbish the kitchen and so on, which leads to economic expansion.

But there is only so much you can borrow, with two new cars in the garage of your new house you start feeling a bit tight and as all your main spending needs are satisfied, you start deleveraging. This leads to an inevitable recession.

Even if a recession might sound crazy at this moment in time, don’t forget that we have had 11 of them since 1945 with the average expansion cycle lasting 58.4 months and the average contraction 11.1 months. The current expansion is already 84 months old which statistically should have led to a recession, but the FED hasn’t allowed for a normal, healthy economic cycle to evolve and is trying to manage economic cycles. The more the economic expansion period is artificially stretched, the stronger the negative economic impact of a future recession will be. A good example to look to is the 2007-2009 Great Recession, which was the longest since the Great Depression.

The Japanese example perfectly demonstrates how monetary easing has its limits. Monday’s data showed that the Japanese economy expanded at an annualized rate of 0.2% in Q2 2016 despite government stimulus.

figure 1 Japan
Figure 1: Annualized quarterly change in Japan’s GDP. Source: Wall Street Journal.

As long term investors, we have to follow the main rule of investing which is not to lose money. Therefore, it is of essential importance to always be looking at risks, which I know isn’t as sexy as buying stocks, but it is what gives long-lasting and outperforming returns.

Among the many risks for investors, today we are going to focus on how safe traditional investing safe havens really are.

Investing Safe Havens

The definition of an investing safe haven states that the investment is expected to retain or even increase its value in market turmoil. The typical safe havens most investors consider are gold, U.S. treasuries—especially TIPS or Treasury Inflation-Protected Securities,—the Swiss franc, and defensive stocks. We shall discuss each of these below.

Gold

Gold is considered the ultimate safe haven asset, but due to its incredible volatility, I have a feeling that it’s retail investors who get burned by it, making gold a used-to-be the safe haven.

In wartimes, gold is the only worthy currency due to rampant money printing, however, we are hopefully not even close to a war, but are printing money like we are in a wartime. Even though gold is the ultimate hedge against runaway inflation, we may want to rethink it as a safe haven due to its volatility.

In the 1973-1975 recession, gold surged from below $100 per ounce to above $200 but quickly retreated to its previous level as soon as things got better. In 1980, due to geopolitical instability, gold surged to above $800 and again returned to the $350 levels in 1982. Gold notched up a bit in the 1987 bear market and in the 1991 recession, but did not move in the 2001 recession. In 2002, gold started its majestic bull run from prices around $300 to the highs reached in 2011 of above $1,800, only to retreat to $1,100 this winter. It has again surged to current prices of $1,350/oz.

figure 2 gold price
Figure 2: Gold prices since 1973. Source: Gold Price.

I wouldn’t consider an asset that fell 35% in the 2008 bear market to be a safe haven. Especially given gold’s volatility in the last 10 years, investors should know that gold at this point looks more like a speculation than safe haven investing.

That does not mean we don’t believe you should have some allocation to gold as a protection against an all out fiat currency collapse, just know it will be volatile.

U.S. Treasuries

U.S. treasuries carry two risks; one is the default of the U.S. government which is highly unlikely, while the other is inflation which is not so unlikely given the continuous monetary easing. Therefore, in order to really look for a safe haven, TIPS (Treasury Inflation-Protected Securities) should be examined.

If inflation hits 2% or more, 30-year treasury yields would give a negative real return. On the other hand, TIPS have a much lower yield, with the current spread at 162 basis points which is amongst the lowest spreads in the last five years but would keep giving you a positive real return in inflationary circumstances. The current difference of 1.62% is a lot, but protection always comes at a cost.

figure 3 tips vs yield
Figure 3: 30 year treasuries vs. 30 year TIPS – yields. Source: FRED.

The difference in yields demonstrated in the figure above is pretty high which suggests thinking about diversification in the safe haven bond portfolio. As the main rule of investing is not to lose money, TIPS should be considered.

The Swiss Franc

The Swiss franc (CHF) is similar to gold, when things get rough people flock to it, but you have to sell quickly when things get better. In August 2011 the CHF surged due to contagion fears related to the European debt crisis, but it quickly returned to previous values.

figure 4 chf
Figure 4: USD per 1 CHF. Source: XE.

The CHF is not a long term safe option as it is very volatile and does not provide long term protection.

Defensive Stocks

Defensive stocks usually perform well at the beginning of a bear market but are dragged downwards in later stages as investment funds get tight on liquidity. Defensive stocks can be found in the utilities sector and consumer staples. In the current environment, if you have two stocks with similar valuations and yields you might want to choose the more defensive one as it will limit your losses should a bear market arrive.

Conclusion

Talking about risk is always thankless, you become the grumpy fellow at the party while everyone else is having fun. But investing shouldn’t be about fun, it should be about creating sustainable long-term positive returns.

In this article we have discussed how some safe havens are not that safe due to their volatility and speculation around them, like gold and the Swiss franc. Being protected always comes at a cost which is relatively high when comparing treasuries and TIPS, but it is necessary as global monetary easing and stimulus continues.

The main conclusion is that you have to assess your risks for the returns you are getting. The S&P 500 is up only 4.9% per year in the last 24 months, so consider if those meagre returns are worth the risk of losing more than 20% if a bear market comes along.

The best protection should be diversification that includes TIPS, gold, defensive and growth stocks, domestic and emerging markets. If you continually rearrange the weights in order to minimize risks, you can for certain outperform the market with less risk.

 

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As The S&P 500 Reaches New Highs, Asset Inflation Continues


  • All factors are indicating an artificially created asset inflation.
  • Earnings are expected to decline with economic outlook being constantly revised downwards.
  • Gold is gaining alongside stocks which confirms that all assets are inflated.

Introduction

Amidst all the turmoil from BREXIT, negative interest rates and global downward economic growth forecasts, the S&P 500 has reached a new high. On Monday it closed at 2,137.16 points, overtaking the previous high of 2,130.82 from May 21, 2015. The Monday record was surpassed again on Tuesday and Wednesday, with Wednesday closing at 2,152.43.

figure 1 s and p 500
Figure 1: S&P 500 in the last 5 years. Source: Bloomberg.

This new high isn’t significant in terms of real returns as the market hasn’t really gone anywhere in the last 14 months, but it is significant from a psychological and confidence perspective. In this article we are going to look for the breakout reasons and fundamentals, and analyze potential risks.

Fundamentals

It’s pretty straightforward: if earnings grow then the S&P 500 is also supposed to grow, if earnings decline and the S&P 500 grows we can assume we are in a bubble. At the moment, earnings are not growing and this earnings season will probably be the fifth consecutive quarterly earnings decline. In total, net income is down 18% since its 2014 high.

figure 2 earnigs
Figure 2: S&P 500 index and earnings. Source: Bloomberg.

The 18% decline isn’t that bad when compared to the average 36% earnings decline in recessions since 1936, but currently we are not even close to being in a recession.

Investors seem optimistic and willing to pay a hefty premium for stocks. The current S&P 500 PE ratio is approaching 25 and it has been higher than 25 on only two occasions in the last 100 years, in the dotcom bubble and in the midst of the Great Recession when earnings plunged.

figure 3 S&P 500 pe ratio
Figure 3: S&P 500 PE ratio. Source: Multpl.

As earnings are not growing and fundamentals are deteriorating, there must be something else that creates investor optimism.

Economic Data

As stock prices reflect future expectations, a look at GDP forecasts will give a good perspective on the rationality of the above valuations. In June, well before the BREXIT vote, the World Bank lowered its global growth forecast from 2.9% to 2.4% indicating more trouble for corporations. The International Monetary Fund has cut its forecast for the U.S. from 2.4% to 2.2% for 2016 but expects a pickup to 2.5% in 2017, while the FED expects moderate and stable economic growth at 2% for the next few years. In greater detail, the media highly promoted the 287,000 new jobs added recently but failed to focus on the increased unemployment rate from 4.7% to 4.9%.

One might wonder if the above mentioned data is enough to sustain a PE ratio of 25 as historically the economy has grown faster than 2% and the S&P 500 has had lower PE ratios, again an indication that asset prices are inflated.

Low Bond Yields 

The inflation in asset prices is especially visible in fixed income investments. With 30% of global sovereign debt charging a negative yield, investors push bond prices higher and higher in a desperate search for positive yields. This is further enhanced by the central banks of Europe and Japan actively buying corporate bonds on the market, and even stocks for the latter. As long as central banks relentlessly continue buying securities, it is very difficult for stock markets to experience substantial declines which means that small risks are being smoothed out by monetary policies while the big black looming risk grows bigger and bigger.

Not only that, but capital flows toward fixed income funds are reaching record highs.

figure 4 etf flows
Figure 4: Cumulative fixed income ETP flows in billions. Source: Bloomberg.

S&P 500 Sector Performance

One could argue that the above mentioned corporate earnings decline is mostly the result of lower commodity prices and declining earnings in the energy sector, but only 4 of 10 sectors will see earnings growth in the coming earnings season.

figure 4 earnings per sector
Figure 5: S&P 500 expected earnings growth per sector. Source: FACTSET.

Despite that the energy sector is expecting the worst decline in earnings, its performance in the last 6 months has been the best as things have stabilized a bit. On the other hand, the fact that utilities, energy and materials were the best performing sectors in the last 3 months shows that investors are looking for investments that protect against inflation and have constant, recession-proof yields.

figure 5 sector spdr
Figure 6: S&P 500 sector performance in the last 6 months. Source: Sector SPDR.

The same conclusion related to the search for inflation protective assets can be reached by the looking at the continuing surge in gold prices.

figure 6 gold prices
Figure 7: Gold prices in the last 12 months. Source: Bloomberg.

Gold is usually not correlated with stocks, but from the chart above we can see that both gold and stocks are increasing which again leads toward the conclusion that all asset prices are inflated.

What To Do

It is difficult to be smart in such an artificially created situation, but stock picking and “stick to what you know” might be the best option. You must evaluate the companies in your portfolio and identify how they will perform in the uncertain times that are ahead as asset inflation, possible real inflation in the future, and higher rates will wreak havoc among securities.

Now is the time to be smart. Investors should grasp the opportunities given by the high liquidity but at the same time think of the potential risks if anything changes in the current financial monetary easing system.

 

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BREXIT Aftermath: Where to Look for Returns & What to Avoid Now


  • The U.S. and Europe are overvalued, especially seeing the current political situation and economic fragility.
  • What’s about to hit Europe and the U.S. already hit emerging markets in 2015. There are opportunities in emerging markets now, but where?
  • Bonds seem the riskiest asset of all with no yield and huge potential downside.

Introduction

After last week’s BREXIT vote the markets have been in a free fall with a slight recovery yesterday. But savvy investors have been expecting this and it has been a recurring theme at Investiv Daily that stocks are overvalued. In such an overvalued environment it is normal that inflated asset prices take a beating at any sign of future uncertainty.

As one’s misfortune is another’s fortune, this article is going to elaborate on what to look for and what to avoid in order to limit risks and maximize returns.

The U.S. Stock Market

The U.S. stock market is fully valued and therefore the decline should not have come as a surprise. The S&P 500 has been moving sideways for the last year and a half and many are expecting a recession. In such an environment the risks are high and the potential returns very low.

figure 1 pe earnings
Figure 1: S&P 500 PE ratio and earnings. Source: Multpl.

With a PE ratio of 24 and declining earnings, the only way for investors to realize capital gains by investing in the S&P 500 would be through the formation of an asset bubble. With the current political turmoil, slower U.S. productivity, lower employment participation and strong dollar, this seems like a very unlikely scenario.

On the other hand, those factors might start a recession that could easily lower the S&P 500 to the average historical PE ratio of 15 which would cause a 1,300 point, or 35% drop. Therefore, the conclusion is that the S&P 500 carries a lot of risks with limited upside.

Emerging Markets

Emerging markets were the thing to avoid in 2015, but they still possess long term factors that should make them the long term investment winners, especially if bought at these depressed prices. Let us focus on Brazil as an example.

Brazil was hit by various corruption scandals and by the deepest recession in the last two decades. But, Brazil is still a young country rich in natural resources and on the road to becoming part of the developed world, minor setbacks are normal and should be used as an investment opportunity.

figure 2 brazil GDP
Figure 2: Brazil’s GDP in billions of US dollars. Source: Trading Economics.

Brazil’s GDP grew from $1,107 billion to $2,346 billion in ten years which still represents a yearly average growth of 7.7%. As the market has already factored in the chance of a Brazil bankruptcy, the risks and rewards of investing there are opposite from what they are in the U.S., as there is no risk of a U.S. bankruptcy.

Brazil’s current CAPE (Cyclically adjusted 10 year average price earnings ratio) is currently 3 times undervalued at 8.2, while the S&P 500 has a CAPE ratio of 24.6. The undervaluation is probably the reason why Brazilian stocks have behaved very well in the last few days. The Brazilian stock index is still in positive territory for the month and year to date. On top of the relative stability, U.S. investors could also gain from currency benefits as the oversold real is slowly returning to its real exchange value toward the dollar.

figure 3 usd brl
Figure 3: USD vs BRL in the last year. Source: XE.

To conclude, Brazil represents a young, resource rich country where it seems that all that could go wrong did go wrong last year. More positive news than negative news should now be expected. On top of that, it is one of the most undervalued markets in the world.

Europe

The situation in Europe is similar if not worse than the one in the U.S. To put it simply, the markets are in an asset bubble as the European Central Bank has been issuing huge amounts of liquidity with the hope of faster economic growth and some inflation. It succeeded for a while but the BREXIT issue will for sure have a negative impact on current economic growth when coupled with the overvalued markets, the risks outweigh the rewards.

The average PE ratio in Italy is 31.5, Netherlands 28.5, United Kingdom 35.4 and Germany 19. There is also the euro issue where any political turmoil could weaken the euro and lower investment returns for U.S. investors.

Europe should be avoided until asset prices reflect the real state of the economy and the political situation, thus far below current prices, at least 50%.

Gold and Bonds

It is uncommon to put gold and bonds in the same basket but as they both have practically no yield with negative interest rates on the most secure government bonds, it seems the right choice.

Gold is currently at its year high as investors look for safety. The problem with gold is that it has no yield and most investors come too late to the party as gold primarily appreciates at maximum turmoil as it has done in the past few days.

figure 4 gold prices
Figure 4: Gold prices in the last year. Source: Bloomberg.

If political turmoil persists and inflation arrives due to the high liquidity, gold might be the winner, but any signs of stabilization would negatively affect gold. It can be concluded that gold represents a good hedge and could be a part of a well-diversified portfolio. Investors that seek a riskier investment than gold itself could go for gold mining stocks that offer a dividend yield and potential growth, though gold mining stocks also come with much more volatility.

As for government bonds, the risks seem to outweigh the rewards. Yes, it is possible to make capital gains if interest rates further decline, but this defies logic as there is no point in holding negative yielding bonds. On the other hand, if yields increase bonds could fall tremendously as a 100% increase in bond yields should consequently lower bond prices by 50%. Therefore, the current situation with bonds isn’t what’s typically assumed about bonds—low risk with high rewards—as right now they are high risk with low rewards.

Conclusion

At this point, after a 7-year bull market and high liquidity provided by central banks, investors should be wary of being overweight in the same things that were good 7 years ago. Many analysts have forgotten how to analyze risk as we have not seen a bear market since 2009, but this is exactly the time when one should look at risks before rewards. High asset prices and low yields mean that investors do not see much risk and are willing to pay hefty prices, but this is exactly the kind of situation that can bring lots of investment pains.

Any signs of recession, the continuation of the decline in corporate earnings, and a shift from the current investor’s perception that central banks are still able to save the markets with additional intervention, could easily send the stock market down by 30%. Assess your risks, estimate the rewards, and position your portfolio accordingly.

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How to Prepare Your Portfolio For The Next Recession or Stock Market Crash


  • The risks of a slowdown are higher than the upside.
  • Fundamental trends are negative in advanced economies while emerging markets show higher growth rates and are cheaper.
  • It is important to create a diversified portfolio with uncorrelated assets.

Introduction

In an environment where it seems maximum potential for the U.S. economy has been reached, the St. Louis FED chief, James Bullard, has said in his most recent report that he favors only one interest rate increase through 2018, which would at best keep things stable. His view is further supported by the fact that the unemployment rate is sitting at below 5%, and the Personal Consumption Expenditures PCE inflation—measured by the Dallas FED—is at 1.84%, both of which signal that the economy has reached its maximum potential.

1 figure trimmed inflation
Figure 1: Trimmed mean PCE inflation. Source: FRED.

The scary part of the report is where Mr. Bullard describes how forecasts are made based on the current situation, which will most definitely change. What is difficult to predict is the direction of the change therefore, forecasts are bound to be incorrect and under the influence of various risks like a return to the normal Phillips curve influence where low unemployment triggers inflation, or a recession even if no current data indicates the possibility of one. Thus only an extremely positive scenario would trigger interest rate increases if fundamentals like inflation or productivity stay stable.

2 figure fed stlouis
Figure 2: St. Louis FED’s U.S. macroeconomic outlook. Source: St. Louis FED.

The conclusion is that practically anything can happen, and the FED has absolutely no idea as to where the economy will be in a year or two. Even FED Chairwoman Yellen admits that the 2013 expected interest rates of 4% for 2016 were too high and that an aging society and a slump in productivity growth will keep the subdued economic indicators persistent.

In such an uncertain environment, an investor should look at the best ways to protect his downside and maximize his upside.

Investment Ideas

Let us start with bonds where interest rates have been declining since the start of this century.

Bonds

3 figure bonds
Figure 3: 10-year government bonds yields. Source: Wall Street Journal.

As bond prices are inverse to bond yields, any increase in yields would precipitate bond prices, thus bonds are currently low yield and high risk. Usually considered safe havens in recession times, bonds currently do not provide such protection as it is better to keep cash than bonds with negative interest rates. There is the option of further bond price increases, but that is a highly unlikely scenario as bond yields are at historical lows.

The Stock Market

The S&P 500 is still holding well, but does not manage to break the previous highs despite having come close several times.

4 figure s&P 500
Figure 4: S&P 500 in the last 12 months. Source: Bloomberg.

The S&P 500 dividend yield is 2.12% which might look tempting when compared to the extremely low bond yields, but it is meagre when compared to the historical mean of 4.39%. A return to the mean would result in a drop of 50% or more of the S&P 500 index. The conclusion here is the same as with bonds: High risk, low returns.

But there is an option with stocks that should limit the downside. Dividend stocks that will not see their cash flows affected by a slowing down in the economy are always assets toward which investors run when trouble comes. Examples can be found in telecommunication, consumer staples and healthcare.

Emerging Markets

If the reason for economic stagnation in the developed world is an aging society, slow productivity growth and emerging markets competition, a contrarian thesis would be to invest into emerging markets.

Emerging markets have a relatively young population and are currently shunned by investors as too risky amidst a commodity price slump. But no matter the current issues, the World Bank expects emerging markets and developing economies to grow at rates north of 4% in the long term, while advanced economies are expected to grow below 2%.

Currently, advanced economies are preferred by investors as they regard them as secure, but long term structural trends are strong in place even if we do not choose to see them. What China has done in the last 15 years could be the same as India is about to do. Brazil will probably also return to growth someday.

The following figure will show that the current developed world impression of asset security is mostly funded by debt which is unsustainable in the long term.

figure 5 investment position
Figure 5: U.S. net international investment position. Source: Bureau of Economic Analysis.

On top of that, emerging markets are much cheaper than developed ones according to the Cyclically Adjusted Price Earnings (CAPE) ratio which takes into account earnings from the past 10 years.

figure 6 global cape
Figure 6: Global CAPE map. Source: Star Capital.

For long term investors, the less risky option might be to dig for good investments in emerging markets with positive demographics and a strong growth outlook. Currently those investments are out of favor, but this is exactly the environment where investments give the best returns.

Gold

Gold is a doomsday investment, it protects you against inflation and is the metal that surges in difficult times. Typically as the economy does well, stocks grow and gold declines because gold has no yield. The opposite happens in turmoil.

7 figure guardian precious metals
Figure 7: Gold and stocks cycle. Source: Guardian Precious Metals.

You can invest in gold by buying it physically, through ETFs or by buying gold miner stocks.

Conclusion

As always, good diversification should provide sufficient downside protection but a portfolio has to be diversified with uncorrelated assets.

If you have Ford in your portfolio and then you add some Caterpillar, that is not real diversification. Gold, emerging markets, cash, and quality stocks should enable a portfolio to weather economic hardships.

Don’t forget that after every recession comes a recovery, so be ready to increase your exposure to stocks when assets are cheap, even if everyone will be thinking that there is no tomorrow.

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Soros is Back and Betting Heavy On Gold


  • Structural debt issues in China and European fragility will limit global growth.
  • Soros is overweight gold and short the S&P 500.
  • He trimmed his U.S. stock portfolio by 37%.

Introduction

George Soros is an Hungarian-born, 85-years young hedge fund manager and philanthropist famous for his daring investment bets.

He is most famous for ‘breaking the Bank of England’ in 1992 by shorting the pound. Interest rates in the UK were much higher than in Germany and with the pound overvalued, Soros borrowed heavily to short the pound and forced the UK to exit the European exchange rate mechanism. The total estimated profit for Soros was one billion pounds.

There is a lot that can be learned from Soros, and there are $24.7 billion reasons (Bloomberg Billionaires) we should at least follow what the guy is doing. What is even more impressive than the Bank of England play is his average return per year by his Quantum Fund. While he was active at the helm of his fund, Soros managed to achieve returns of 26.3% over a 40-year period.

1 figure returns
Figure 1: Soros vs Buffet. Source: Hedge Fund.

Net of fees, a mere $1,000 dollars invested in the Quantum Fund would return $11.3 million after 40 years, not bad. Soros retired from active management in 2011 but now he is back and this article is going to elaborate on what is he doing.

Current Macro View

In May, Soros disclosed a 19 million share stake in the world’s largest gold producer, Barrick Gold (NYSE: ABX). We almost don’t need to mention that ABX is up 168% year-to-date, which again shows that Soros still has it, even at 85. In the meantime, he also cut his U.S. stock holdings by 37% in the first quarter of 2016.

Soros is basing his bearish moves on various global uncertainties. He is worried that China will not be able to manage an economic slowdown and that its increased debt levels are just postponing the inevitable as lending is mostly used to cover for bad debt. He compares the Chinese economy to the U.S. 2007-2008 economy fueled by debt. Currently $2.4 trillion worth of loans are estimated as risky by Bloomberg, as borrowers’ interest payments are higher than their earnings. This represents 23% of Chinese 2015 GDP.

Soros is also bearish on Europe and as he said that “Europe is in mortal danger” due to its refugee crisis, potential Brexit and Greece. The migration crisis is not such a hot topic currently as things have settled, but the problem is not solved and the situation remains fragile with more than 2 million Syrian refugees in Turkey. On top of that, the Brexit vote shows how fragile Europe is and how any economic destabilization could soon reignite the Greek issue as the problems in Greece were never solved, just postponed by giving Greece more loans.

It is interesting how Soros focuses more on the macro trends like the long term debt trend in China, and refugee and Greek issue in Europe, and not so much on day-to-day news about monetary policies or market movements.

Current Trades

A bet that might scare a lot of people that have investments in mutual funds or ETFs is that besides the 37% decrease in his stocks exposure, Soros also bought 2.1 million put options on the SPDR S&P 500 ETF and further increased that bet by buying 1 million call options of the SPDR Gold Trust ETF. Buying put and call options means that Soros expects the markets to move relatively soon in his direction.

(A put option is a contract that gives the buyer the right to sell 100 shares of an underlying stock at a predetermined price for a preset time period, while a call option is a contract that gives the buyer the right to buy 100 shares of an underlying equity at a predetermined price—the strike price—for a preset period of time.)

The current cost of put options expiring in January 2018 is 10% of the SPDR S&P 500 ETF. The maximum Soros can lose is his total investment while if the S&P 500 declines more than 10%, he is in profit. A 20% decline would give him a 100% return, while a 30% decline would give him a 200% return. Similar risks and returns ratios are in place for his Gold ETF call options bet.

Conclusion

Soros has already made wonderful returns on his gold bets and probably some small negative returns on his S&P 500 shorts but that is the way he plays his game. By looking at long term macro structured trends like debt levels, bad debts, inflation or deflation, he manages to approximately time the markets, and by daring to put a large stake of his portfolio in it, he manages to get extraordinary returns (ABX is his largest current position).

Of course, Soros is not always right. In 2000 Soros constantly preached the inevitable burst of the tech bubble but was caught on the wrong side of that trade as he wanted to make money both in the creation of a bubble, and in its bust. In the first 4 months of 2000 his fund was down 22%. Monday’s stock price surge is working against Soros but this shows that in order to make extra returns, an investor has to be willing to also take extra risks and weather unfriendly market moves.

For those who want to know more about Soros and his investment style, a great start is his book Alchemy of Finance which gives great financial insight and an elaboration of the reflexivity theory, but is a difficult read.

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Gold – Investment or Speculation?


  • An increase in interest rates should push gold prices lower while a recession should push them higher.
  • Gold mining cash costs are much lower than current prices and do not provide a safety margin.
  • The high risk/high return investment strategy for gold is mining stocks as they are down 80% from their highs but have rebounded almost 100% in the last few months from their January low.

Introduction

Gold is a controversial investment asset. Some say that is has no function and therefore no value while other see it as the most secure asset to run to in case of trouble. This article is going to elaborate further on both perspectives relating them to the current situation on the gold market.

Influences on the Price of Gold

The 20-year gold price chart shows how volatile gold has been. Gold has traded from lows of $250 per ounce in 2001 to highs of $1,830 per ounce just ten years later in 2011.

1 figure gold prices
Figure 1: Gold prices per ounce. Source: Bullion Vault.

In the shorter term, the January turmoil on financial markets pushed the price of gold from a December 2015 low of $1,051 to a recent March 2016 high of $1,293. A more hawkish tone from the FED on increased interest rates pushed gold prices down again to the current $1,226. Higher interest rates make it difficult for gold to compete with treasury notes that also represent safety, and on top of it have a yield.

The strongest influence on gold prices comes from interest rates and the figure below shows how the current historically high gold prices are correlated to low interest rates.

2 figure fed rate gold prices
Figure 2: Gold price vs real interest rates. Source: Goldcorp.

But it isn’t only interest rates that influence the price of gold. Gold is usually seen as an inflation hedge, so if higher interest rates will be a consequence of inflation due to the pickup in the economy, higher oil prices and increased demand for houses, gold prices might still rise or stay stable. Also, gold is considered a hedge against currency devaluation due to its relatively stable supply and limited availability but interest rate increases would only make the dollar stronger and therefore devaluation is not a risk the US currency runs at the moment.

As with any other commodity, supply has an influence on gold prices. Maybe not such a strong one as with other commodities as gold is mostly used for investment purposes. In relation to supply, higher gold prices enabled less cost efficient projects to come online and thus gold production has constantly increased in the last seven years.

3 figure gold production
Figure 3: Global gold production and miners expected future production. Source: Goldcorp.

If gold prices decline, the output will immediately decrease as expensive mines are shut down, but the gold production curve shows that gold is a rare metal and mining costs are high.

4 figure gold cost curve
Figure 4: Gold production cost curve. Source: Mineweb.

At the current gold price, less than 50% of gold mining is profitable if we take capital investments, depreciation and total cash costs into account as the average production cost is $1,314 per ounce. If we look at only mining costs it tells another story as average mining costs are $749 per ounce. This means demand for gold is the one influencing prices. From a supply perspective it is difficult to put a bottom to gold prices as a big chunk of production can be cash flow positive at prices of below $500.

Demand for gold is mostly influenced by the already mentioned interest rate and by fear. As the market is near all-time highs there is not much fear in the air but the January market dip quickly pushed gold prices up by 25%. The more turmoil there is on the markets the more people will seek refuge in gold as—due to limited supply and costly mining—it gives certainty in difficult times.

Investment Opportunities

There are several ways to be exposed to gold. One is just to directly buy a bar of gold and hold it in a safe, but there are more sophisticated ways to be exposed to gold as well.

Gold ETFs are a good choice as they trade as a stock, so you don’t have to physically own the gold as they track the price of gold. The biggest gold ETF is the SPDR Gold Trust ETF (NYSEARCA: GLD). An even more volatile strategy but one that can also have a dividend yield attached to it is to invest into gold mining stocks. Gold miners are much more volatile than gold. For example, if a miner breaks even at $1,200 per ounce, every dollar above that price is pure profit and therefore mining stocks are much more sensitive to fluctuations in gold prices.

figure 5 gold stock etf
Figure 5: Van Eck Vectors Gold Miners ETF. Source: Bloomberg.

As gold prices fell 42.5% from a high in 2011 of $1,830 to a 2015 low of $1,051, gold mining stocks have fallen by 79.5%. As gold rebounded to the current $1,226, the Miners ETF rebounded almost by 100% from a low of $13.03 to a high of $25.83. A sharper decline in gold prices could easily push the price of the Miners ETF down by more than 50% and vice versa for an increase in gold prices.

Conclusion

If you like Warren Buffett you will never invest in gold as according to Buffett it is just a metal that we dig out of the ground, transform into bars and put under the ground again while it produces no economic benefit whatsoever. It is estimated that there is about 181,300 tons of gold in the world, that at current prices would be worth $7.8 trillion. For that money you can but one third of the US land that has an estimated value of $23 trillion.

Buffett’s point is that one third of US land is a much more sensible investment as you produce something and enjoy economic returns while gold is just a piece of metal. But, in times of financial trouble when people panic and lose faith in the economy or the currency, gold prices shoot up. As gold does not produce anything, maybe it should not be called an investment but more a speculation.

 

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The Case for Gold Now


Gold has had a resurgence of late. Is it because in this volatile market investors want to put their money toward something solid, or is it something else?

On the surface, yes, investors are putting money on gold because it feels safer than the current rocky seas of our global markets. Gold has always been a safe haven, and after the stock market’s awful start to the new year that has continued into February prices for the precious metal have risen by about 6%. After a few years of falling value, it appears that the downward trend has reversed and gold is gaining but is not yet at its peak, which makes now a good time to invest. And that’s just for physical gold, gold ETFs are on an uptrend as well.

However, the Fed has recently raised interest rates and there is a promise of more rate hikes coming. Gold doesn’t pay interest, which should mean now would be an unfavorable time to buy gold, but gold is defying this convention and rising anyway. Why? Because in its last meeting, the Federal Reserve articulated a less hawkish stance on a previously projected rate rise in March due in large part to the slowing in China that is dragging down the predictions for the global economy—and the U.S. economy— along with it. This vocalized a growing fear and has gold gaining to its highest price in 3 months.

But apart from market volatility and growing fear, what reason is there to buy gold? Answer: there are other things happening in the gold market that investors should be acutely aware of as they will make a dramatic impact on the future value of gold.

As I’m writing this, gold sits at roughly $1,126, but by the end of the year I believe we could see it go to $1,300 or higher, and in the years to come it is bound to become far more valuable. The following are few of the big circumstances that make gold a good bet now while prices are still relatively low.

Central Banks Are Collecting Gold

For several years now, central banks world-wide have been beefing up their holdings of gold, especially China and Russia. Of course this may be safe-haven buying, or related to diversification, but other factors make me think that there is more going on. In fact, figures from the People’s Bank of China show that they aren’t merely setting gold aside for a rainy day, they have in fact boosted their gold holdings by more than 6% since announcing in July 2015 that they have had a 57% percent jump in their gold holdings in the last 6 years and have been urging the Chinese people to buy gold, resulting in record imports.

So why are China and other countries stock-piling gold? It likely has to do with the devaluation of currencies the world over.

When the world was plunged into recession in 2008 – 2009, the Fed and other central banks around the globe stimulated economies by printing massive amounts of money. This resulted in boosted economies, certainly, but it was an incredibly risky monetary experiment, and now currencies are being devalued as a result of the money printing and central banks are collecting gold as a hedge. Central Banks are now running out of options for boosting up their economies and are reaching for tools that seem to point to a race toward devaluing paper currencies around the world that could result in an all-out currency war, as evidenced most recently by Japan’s new negative interest rate policy.

Gold has become the safe haven of choice for anyone with exposure to a weakening currency, and Michael Armbruster of Altavest said to MarketWatch that “gold’s strength is based on flight to safety from the world’s money-printing central banks.”

As countries continue to accumulate gold in huge quantities to back their currencies, it is unlikely that the price of gold will remain low for much longer.

Another Global Recession is Coming

Volatility in global markets, economic slowing world-wide, plunging oil prices, geopolitical uncertainty, and trillions of dollars of debt piling up across the globe have recently sparked a lot of speculation about the next financial crisis. Some of the biggest names in the financial world have warned of another global recession coming as early as this year, with George Soros citing a collapse in China and Jeffrey Gundlach warning that the high-yield debt market could implode. If either of those predictions become true, or worse if they both did, the world would undoubtedly find itself plunged into another recession that could very well be more harsh than the last.

On national levels, it’s undeniable that the U.S. has enormous debts, as do France, Britain and Japan, etc. One unknown event could send a nation into what Vice called a “debt death spiral” reminiscent of Greece, but on a much larger scale. The U.S. alone has accumulated over $19 trillion in national debt, and there is a $29 trillion corporate debt hangover that could prove to be a catalyst for another recession.

Should the debt bubble burst, central banks will have to develop new tools with which to boost up their economies—like the Federal Reserve’s multiple rounds of Quantitative Easing after the last financial meltdown—though a meltdown of the world’s debt bubble may be of too great a magnitude to impact an inevitable collapse. Such a crisis would see people scrambling into the gold safe haven in droves and would inevitably drive up the price of the yellow metal far higher than the $1,900 an ounce it reached in August 2011.

The World is Running Out of Mineable Gold

In the next two decades rare gold will become seriously scarce.

Goldcorp, one of the largest gold producers in the world, released a slide in 2014 that estimated peak gold production was expected in 2015. When peak gold is reached global production declines until gold prices spur producers into identifying new sources and begin mining them. While peak gold happens regularly—four times since 1900—new deposits of the precious metal are becoming increasingly less common, and the new deposits that are being found contain smaller quality quantities that are becoming increasingly harder to mine.

MarketWatch quoted Eugene King, European metals and mining analyst at Goldman Sachs, as saying “The combination of very low concentrations of metals in the Earth’s crust, and very few high-quality deposits, means some things are truly scarce.” It is an inevitability that gold producers will run out of deposits of mineable gold, the question is when. Goldman Sachs and the Visual Capitalist have both reported that it will happen within the next 20 to 30 years.

History has taught us that when gold looks like its going to hit absolute zero, producers expand their search for gold to less accessible places and technology advances to create new methods of extracting the commodity. However, the reality is still that technological advances of a certain magnitude take time, and that gold is scarce and this planet will run out of new deposits of it.

For more than 4,000 years gold has been used as a measure of wealth, and I see that as only becoming more true in the coming years and decades. While gold can be recycled and reused, the impending shortage of new gold will send prices skyrocketing if there is even gold available to buy. For those investors who invest in gold now, this will mean that their holdings will skyrocket in value. For those who don’t, this could mean that gold will become unattainable.