Gold And Stocks

Markets were resilient as September and the third quarter closed, registering gains despite economic and political uncertainties. The S&P 500 and Nasdaq closed last Monday, September’s last trading day, up 0.4%, while the Dow Jones gained nearly 0.1%. The S&P 500 notched its 42nd all-time high for the year, making it the best September since 1997 and the best start to an election year ever.

QUICK HITS:

Since 1950, the S&P 500 has increased in the last three months of the year by more than 4%, and it’s up 80% of the time.

NVIDIA gained 2.9% this past week after CEO Jensen Huang confirmed that the company’s artificial intelligence chips are in full production, easing concerns about delays.

These consist of seven of the largest stocks by market capitalization: Apple, Microsoft, NVIDIA, Alphabet (i.e., Google), Amazon, Meta, and Tesla. The S&P is a weighted index, so the largest stocks have their gains amplified due to their higher weighting.

These seven stocks had an oversized impact on the market's returns. In the first six months of the year, the Magnificent 7 made up 59.5% (just under 60%) of the S&P's gains. To put this into perspective, the full market-weighted S&P was up 14.5% in the first half of the year. Without the Magnificent 7, the S&P would have only been up 5.86%.

Gold is Doing a Rare Thing: 5 Things to Know Before You Buy

Gold (GC00 +0.20%) is glittering, though not necessarily for the reasons everyone is talking about. It’s rare for gold to outperform stocks, but it's doing so this year. The metal has hit no fewer than 40 record highs, the latest on Sept. 26, when it reached $2,695 an ounce. Prices got a lift after Iran attacked Israel. Its 28% year-to-date return beats the S&P 500’s (SPX +0.90%) 21% gain.

Short-term trading is part of it. Hedge funds have piled in—collectively, they are more bullish than at any time since at least the mid-1980s, according to an analysis of futures market data by Bespoke Investment Group. Some Wall Street firms expect more gains: Bank of America and Citigroup see gold at $3,000 next year, which would represent an 11% gain from recent prices.

But what’s really behind gold’s ascent? Everyone has a theory: falling interest rates, central bank buying, the rising deficit, or a mix of negatives like wars, pandemics, and the erosion of the dollar’s purchasing power.

There’s truth in all of it, but most of these explanations aren’t as strong as they appear. Gold has support, but it’s important to understand what drives it, especially if you’re considering adding it to your portfolio.

Consider the interest rate narrative: The idea is that gold should rise as rates decline, which pushes down bond yields and makes bonds less appealing. Gold’s rise this year coincided with the market’s anticipation of rate cuts by the Federal Reserve, along with hopes for more cuts in the pipeline.

But there’s a muddled history of gold and interest rates: According to a 2021 study by researchers at the Federal Reserve Bank of Chicago, soaring inflation expectations from 1971-80 coincided with a surge in gold. The metal’s prices then fell in the early ’80s as inflation and rates started cooling.

In more recent history, gold has been inversely correlated to long-term “real” yields, adjusted for inflation. The idea is that if you own a “risk-free” Treasury bond, for instance, your inflation-adjusted yield will look less attractive as rates fall. That makes gold—and other tangible assets like real estate—more appealing. From 2001 to 2012, long-term real interest rates fell about four percentage points, accompanied by an “over fivefold rise in the real gold price,” the Fed researchers found.

Fund manager Pimco has estimated that a one percentage-point decline in real rates for 10-year Treasury notes should lead to a 24% increase in gold prices. Yet Pimco acknowledges that the relationship hasn’t held lately—gold rallied in the past two years when interest rates were higher. And the real yield on the 10-year Treasury is historically low at around 1.5%, leaving little room for more declines.

Other forces fueling gold’s rise include central banks. Led by China, India, Poland, and others, central banks bought over 1,000 metric tons of gold in both 2022 and 2023, according to the World Gold Council. Central bank buying has represented up to a quarter of global gold demand in recent years. However, purchases have recently slowed as prices rose, with China stopping gold buying in May. In total, central-bank purchases reached just 183 metric tons in the second quarter, down 39% from 300 metric tons in the first quarter.

Gold still represents only 5% of China’s foreign currency reserves, leaving room for more large-scale purchases. China and other buyers could become increasingly sensitive to gold prices. If the dollar loses value as U.S. interest rates fall, central banks in China and other countries may increase gold holdings, though at a higher cost.

Gold bulls are pinning hopes on retail investors stepping up and buying through exchange-traded funds. Investors pulled more than $4 billion from these funds in 2023 as prices climbed, according to Morningstar data. Money continued to pour out during the first half of 2024, but fund flows turned positive in July.

“Gold ETF holdings are starting to increase,” says Imaru Casanova, portfolio manager of the VanEck International Investors Gold fund. “We see the re-emergence of Western investors as a very strong near-term catalyst.”

In the long term, gold bulls argue that the metal will hold up as the dollar or other currencies lose value. This ancient argument is often promoted by those concerned about governments inflating away the value of their “fiat” currencies. However, gold’s performance relative to other assets, such as commodities or real estate, remains uncertain. Stocks, which offer cash flows and dividends, could also serve as a hedge.

The idea, though, is that we’re entering dangerous fiscal territory: The U.S. debt has swelled to more than 120% of GDP, and neither Vice President Kamala Harris nor former President Donald Trump has spent much time talking about curbing the deficit or the country’s $35 trillion public debt.

In theory, the growing imbalance between tax receipts and spending will force the government to “print money,” causing the dollar to lose value and prompting people to buy gold due to its relatively fixed supply. The same argument is often made for Bitcoin as “digital gold.”

Some advisors suggest that’s a good reason to buy. “It doesn’t matter who’s in power; both are spending,” says Arnold Van Den Berg, founder of the registered investment advisor Century Management. The firm began adding gold to clients’ portfolios two to three years ago and now allocates 6% to 7% of most accounts, as Van Den Berg is concerned about inflation eroding the purchasing power of the dollar.

“We’re not gold bugs. I bought gold in the 1970s, but we didn’t own it again until a few years ago,” he says. “We can’t predict inflation, but history tends to repeat itself.”

Some fund managers cite geopolitical instability. Gold’s recent rally coincided with Russia’s invasion of Ukraine in 2022. On Oct. 1, as Iran fired missiles at Israel, gold rose 1%. Pimco portfolio manager Greg Sharenow is bullish on gold partly due to increasing geopolitical instability, which he says has fractured the world order.

What’s an ounce worth? Gold doesn’t have cash flows, so analysts try to peg prices to other commodities, demand from China, and factors like jewelry demand in India. Data analytics firm Quant Insight uses mathematical models to gauge which macroeconomic factors are driving prices; they conclude that gold today is most closely linked to copper—a proxy for Chinese growth. The firm says gold is more or less fairly valued, given today’s macro picture.

Other firms see gains ahead. Leuthold Group notes that gold historically does well after each rate cut in an easing cycle and actually gains momentum as the cycle progresses and the dollar weakens. “The rally looks a bit extended in the near term,” the firm said in a recent note, but “there is plenty of room for upside from a medium- to long-term perspective.”

There are a number of options for investors, including bullion, mining stocks, and gold ETFs.

Buying bullion holds a certain appeal and has been a hit for Costco Wholesale: Members rush to snap up $2,689.99 single-ounce bars that quickly sell out. But, apart from the hassles of storage, selling bullion may require a dealer who will charge a markup—sometimes as much as 5% to 10%. Gold miner stocks present a different problem. While they are cheap and easy to trade, their share prices don’t always correlate with gold’s price moves. This has been especially true over the past several years, as higher labor costs cut into profit margins. While gold prices have jumped 71% over the past five years, the VanEck Gold Miners ETF (GDX -0.03%) has returned only 44%. Gold miners have surged ahead over the past few months, but the mining industry’s ups and downs introduce added variable.

This leaves ETFs like the $75 billion SPDR Gold Shares and the $32 billion iShares Gold Trust (IAU -0.24%). These funds charge fees—0.4% for the SPDR fund and 0.25% for the iShares version—but they offer direct exposure to gold, and investors can buy and sell them easily through brokerage accounts.

How much gold to own depends on your appetite for insurance. Arnold’s approach aligns with some asset allocation research, which suggests that gold can smooth out your portfolio’s returns. Most advisors recommend keeping allocations below 15%.

Keep in mind that if gold keeps rallying, it may be due to negative economic news. Pessimism about the economy’s future usually boosts gold, according to academic research. Watch for the University of Michigan's consumer sentiment surveys. Gloomier forecasts from consumers are good for gold but bad for stocks.

“Gold is the counter-investment,” says Martin Murenbeeld, editor of Capitalight Research’s Gold Monitor. “Have a little in your portfolio and hope it doesn’t go up.”

October could rear its head at any time.

Factors to focus on this week:

1. Wednesday - FOMC releases minutes from its mid-September meeting
2. Thursday - CPI Index
3. Friday - Q3 bank earnings
4. University of Michigan Consumer Sentiment Index for October

DATA: Barron’s print edition page 26 10/7/24 Market Week Jacob Sonenshine

Paragraph: one Seeking Alpha online edition 9/4/24 Week In Review Seeking Alpha

Paragraph: two Weekend Wisdom online edition 9/5/24 Q4 Is the Best Quarter Of The Year For Stocks! Are You Ready? Kevin Matras

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