Gold Sad Truth / Commodities / Gold & Silver 2020
Thesad truth is that few people really know very much about gold, especially whenit comes to investing in the metal. They don’t understand what makes it sovaluable and unique, and they know even less what moves its price. Since Idon’t want to spend an hour on why it is so precious, I’ll just try and sum itup in a sentence: Gold is extremely rare, beautiful, portable, transferable, divisiblewithout losing value, and virtually indestructible. Very few things on thisearth can meet all those criteria, and that is why it is the most perfect formof money humankind has ever found.
Nowmore than ever, investors desperately need to know what really influences thedollar price of gold. This is the case given the unprecedented falsification ofasset prices and debt monetization taking place today. Gold is not driven bythe fear of a crash in the major market averages. Nor is it even primarilyconcerned about the inverse correlation to the U.S. dollar (USD). Indeed, themassive interest rate suppression scheme by the Fed since the Great Recessionhas been the main reason behind the outperformance of gold compared with theS&P 500. This is true even in the context of a rising USD.
Thisis why the astute investor begins his portfolio allocation with a 5% investmentto physical gold.
Theabove chart proves that a secular gold bullmarket can and does occur while the USD and stocks are rising. So then, what does have the highest correlation withthe price of gold? The direction of realinterest rates is what matters the most. Hence, it is always important todetermine both the direction of nominal interest rates along with the rate ofinflation in factoring in how much above the minimum 5% physical goldallocation investors should garner.
Ifnominal Treasury yields are rising in the context of relatively benign ConsumerPrice Inflation (CPI), then gold may significantly underperform. This isespecially the case with the miners, which are simply a leveraged play on theprice of the metal. It is clear that exposure to miners during a gold bearmarket can be a very dangerous thing.
However,when bonds yields fall in the context of rising inflation, gold can reallyboost your overall performance. Just take a look at the Gold Miners Index (GDX)shown in blue vs. the Physical Metal (GLD) shown in green in the chart below.
Thetruth is physical gold competes with cash and the “risk-free rate” on U.S.Treasuries. This comparison is calculated by using the interest your moneyreceives in the bank and/or sovereign bonds, minus the rate of decline in itspurchasing power (inflation). This is what hedge funds and the machines on WallStreet are most focused on. Another way of looking at this is that the carryingcost of gold moves in tandem with real interest rates. Therefore, the idealscenario for gold ownership is when real interest rates are falling. And, thatenvironment is best when nominal interest rates are virtually zero andinflation is rising. This means the carry cost on gold becomes negative, whilethe lost opportunity for holding cash is next to nothing.
So,where does the gold sector go from here? Well, we can be fairly certain thatthe Fed will peg the short end of the yield curve at zero for the foreseeablefuture. But the salient question remains to what extent Mr. Powell will allowlonger-duration Treasury yields to rise. Our central bank rejoined the ECB andBOJ in the yield capping game back in Mid-March when the 10-year Note shot upto 1.26% on March 18, from 0.31% on March 9. Such volatility in Treasury yieldsis indeed off the standard deviation chart and scared the Fed out of its mind.Since then, Mr. Powell has authorized the purchase of $1.5 trillion worth ofbonds during the past ten weeks. However, as yields have since settled backinto the mid-single-digit range, the Fed has reduced its purchases from thepeak of $75 billion per day, to just $4.5 billion. For now, the bond market isok with Fed tapering in the context of a $4 trillion annual deficit.
Perhaps this is because the predicted depression isnow here. For example, in 1930, the U.S. Gross Domestic Product plunged by8.5%. Economists now predict that 2020 GDP will crash by 6% after a sharprebound from Q2, which is expected to suffer an output catastrophe of more 52.8%,according to the Atlanta Fed! This type of data is helping to suppress yieldseven while the Fed exits the market. Hence, yields are still near record lows.
In contrast to the depression I predicted earlier thisyear, I am now predicting some of the best economic data on record to bereported in late June and July. Of course, this will only mean we are movingfrom a deep depression to a seriously bad recession. Nevertheless, the rate ofchange in the data will be profound. For example, Continuing Jobless Claims,which surged from 2 million in March, to 25 million in May, will be plunging bythe millions each week during the summer. This should still leave theunemployment rate, which is above 20% currently, a budding teenager by year’send. But again, it is the rate of change in the data that is most important.Will Mr. Powell cap the 10-year Note yield at 1%, or will it be 2%? Or, will hejust let real rates rise until gold and the stock market once again fall apartunder the weight of surging borrowing cost on an overleveraged corporatesector?
Again,determining the direction of real interest rates—and therefore, the directionof gold—is critical because getting caught on the wrong side of this trade canbecome a complete portfolio debacle. For instance, from 1980 through 2000, goldfell from $800 to $250 per ounce, as CPI was falling faster than nominal rates.Likewise, it can spare you from the $1,900 to $1050 plunge that took place from2011 through 2015 when a similar dynamic was in place. By the way, this is alsowhy gold tends to crash during times when the rate of deflation isprofound—nominal rates tend to stop around the zero percent floor, but realrates can still rise due to rampant deflation.
Therefore,in the next couple of months, I will be myopically focused on the “better” newsand how it affects interest rates and the rate of inflation. An improving economy in the context of a dissipatingWuhan virus--coupled with Fed tapering--could (temporarily) send nominal yieldsrising much faster than inflation. This is especially true given theridiculously low level of Treasury yields and the incredible amount of supplythat must be taken in by whatever is left of the free market.
Butthis is the purview of active managers like myself who try to avoid bigdrawdowns in the portfolio. Of course, in the longer-term stagflation is themost likely macroeconomic destination, which is the perfect storm for gold. Theinflation will come from the Fed’s new proclivity towards Helicopter money andits unshrinkable $7 trillion balance sheet that has grown 7-fold in the pastdozen years. The stag part will be derived from trillions of dollars inunproductive new debt being issued and the damage it is causing to public andprivate sector balance sheets.
Thismeans the Fed will be forced to peg the entire yield curve close to thezero-bound range indefinitely, as the economy does not recover sufficientlyenough to allow the 10’s of millions of newly unemployed people to find work. Hence,your stated return on risk-free money will be zilch, just as rising CPI causes realyields to fall into record-low territory.
TheConclusion: Knowing when (and when not) to overweight gold in your portfoliocan provide an opportunity to vastly increase your overall returns.
Michael Pento produces the weekly podcast “The Mid-week Reality Check”,is the President and Founder of PentoPortfolio Strategies and Author of the book “TheComing Bond Market Collapse.”
Respectfully,
MichaelPento
President
PentoPortfolio Strategies
www.pentoport.com
mpento@pentoport.com
(O)732-203-1333
(M)732- 213-1295
MichaelPento is the President and Founder of Pento Portfolio Strategies (PPS). PPS isa Registered Investment Advisory Firm that provides money management services andresearch for individual and institutional clients.
Michaelis a well-established specialist in markets and economics and a regular gueston CNBC, CNN, Bloomberg, FOX Business News and other international mediaoutlets. His market analysis can also be read in most major financialpublications, including the Wall Street Journal. He also acts as a FinancialColumnist for Forbes, Contributor to thestreet.com and is a blogger at theHuffington Post.Prior to starting PPS, Michael served as a senior economist and vice presidentof the managed products division of Euro Pacific Capital. There, he also led anexternal sales division that marketed their managed products to outsidebroker-dealers and registered investment advisors.
Additionally, Michael has worked at an investment advisory firm where he helpedcreate ETFs and UITs that were sold throughout Wall Street. Earlier inhis career he spent two years on the floor of the New York Stock Exchange. He has carried series 7, 63, 65, 55 and Life and Health Insurance www.earthoflight.caLicenses.Michael Pento graduated from Rowan University in 1991.
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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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