HH Gold: The Least Bad Alternative

Back in March 2019, I wrote a post titled “A Golden Macro Opportunity” discussing the extreme compression in volatility we were seeing throughout the precious metals complex and how this portended an equally extreme expansion in vol and a major move on the horizon.

A little over a month later we saw gold break out giving rise to a new bull trend. 

Since that was roughly a year ago and quite a bit has changed *understatement* I figured now is a good time to update my thoughts on the barbarous relic. 

To kick things off, I’ll quickly summarize my fundamental lens for analyzing gold. 

    • The total size of the “investable gold” market is a pittance relative to the global capital stock (equity + debt). Think $1-2trn vs $250-300trn.
    • Demand is what drives price in this equation, not supply.
    • Since gold is not a productive asset it’s the expected real return of other financial assets (stocks and bonds) that drives its marginal demand.
    • When the expected returns for stocks and bonds is high, gold does poorly. When they’re low, gold outperforms everything else. 

Inflation/deflation and crisis insurance are, for whatever reason, the things most people talk about when looking at gold. But, when it comes to the yellow metal, it’s a matter of relativity. Gold is seen as a steady store of value in times when the expected returns for all other alternatives are low. And since the supply is tiny compared to the potential demand, it doesn’t take much of a change in investing preferences to significantly move the needle. 

What are the expected returns for stock bonds then? 

GMO’s 7-year forecast has US large caps averaging -4.9% real returns and US bonds at -1.8%. 

 

The expected annual nominal returns for the S&P over the next decade is roughly 1.1%. 

 

Needless to say, these expected returns leave one wanting.

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Disclaimer: All statements are solely opinions and are for educational purposes only.

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