Love over gold
Gold is that type of asset that does not generate indifference, it has something astounding. It is the unofficial currency of the world. It is the great asset of refuge and store of value. It is accepted and valued. It has multiple applicability. And he has a love-hate relationship with his admirers. It's millenary!
As one of the most volatile assets, we must try to understand the security value it conveys, generating a kind of behavioral contradiction.
It does not allow for a stable flow of income (it does not produce dividends or interest coupons), it has no determinable term, we do not know the real gold reserves. So why do we invest in gold?
Refuge, store of value, comfort and diversification are some of the answers to be explored below.
Relationship between gold and real interest rates
With gold approaching the value of 8 years ago and the peak reached in September 2011, it is interesting to relate this rise to real interest rates.
In a simple way, we can say that the real interest rate is obtained by subtracting the inflation rate from the nominal interest rate.
The chart below shows the relationship between the price of gold and the 10-year real interest rate on US treasury bonds. As can be seen, with the inverted scale in interest rates, the movements of both assets are very similar.
Despite the similarity of the lines in the graph, analyzing the correlation between the returns of both assets, we conclude that this is negligible.
Interest rates have been falling for a few decades and close to zero or even negative in many economies. In the US, in real terms, they were negative between 2011 and 2013, which coincided with the peaks of gold and a peak in the inflation rate, which in 2011 surpassed 3%.
There is then (at least) one common factor in this analysis: inflation. Inflation expectations, in turn, will also be influenced by the expansion of central bank balance sheets, which, as we have noticed, has been brutal. This symbiosis, together with the sharp decline in the value of the currency, seems to continue to give gold strength.
Source: FRED
In the graph above, we have the evolution of the FED balance and the currency circulation velocity (M2V), which is a ratio that relates PIB and the monetary base, that is, the number of times the currency is transacted from an entity to other.
As we have already mentioned, the monetary base has been increasing but the speed of circulation is not increasing, on the contrary. This discrepancy has provoked conflicting opinions about the relationship between inflation, monetary base and circulation velocity. The truth is that data from recent years show that the increase in the monetary base does not seem to be causing inflation. Base money, or currency in circulation, has been growing faster than GDP, which is visible in the M2V ratio.
That is, with the number of transactions in goods and services falling, can we form reasonable expectations of a lasting economic slowdown and low inflation or even deflation?
Asset classes such as bonds are sedated by the work of central banks and with low volatility on the horizon. Opportunities for returns under these conditions are increasingly scarce. Looking for alternative returns and ways to diversify the portfolio can be two very difficult tasks in these times.
Amidst all these uncertainties, and even contradictions and macroeconomic shocks between different theories, gold has stood out and reinforced by the specificities that we have already been describing. The historical return is attractive (I repeat, historical) but what seems to us to be making the difference when making the decision to invest in gold is its ability to diversify in a portfolio and its real characteristics with high liquidity. They convey a certain sense of comfort to a concerned investor.
But it is never too much to warn about the need for assessment and discipline. Making decisions without a personalized investment policy, oriented to the objectives and restrictions of each investor always has consequences. And in this story, sometimes the feeling is stronger than the reason, love over gold...
Vítor is a CFA® charterholder, entrepreneur, music lover and with a dream of building a true investment and financial planning ecosystem at the service of families and organizations.
+351 939873441 (Vítor Mário Ribeiro, CFA)
+351 938438594 (Luís Silva)
Future Proof is an Appointed Representative of Banco Invest, S.A.. It is registered at CMVM.
