The SPDR Gold Trust ETF (NYSEARCA:GLD) looks poised to deliver very attractive risk-adjusted returns relative to current levels. After serving as a valuable tool for portfolio diversification and a stabilizing force amidst an incredible market and economic volatility and uncertainty in 2020 – even reaching a new all-time high in August of that year – GLD recorded a disappointing performance in 2021:
The reasons were mainly the following:
- An increasingly optimistic outlook for the global economy as COVID-19 deaths and cases were finally tamed and economic behavior began to normalize.
- Profit taking on gold earnings to reallocate to other opportunities
- Rising bond yields
Despite this tough year where GLD lagged far behind equity indices like the S&P 500 (SPY) and the Nasdaq (QQQ), GLD once again took the lead against equity indices in 2022, holding up admirably well in the face of the rapid rise in interest rates. as equity markets plunged:
In doing so, it further cemented its massive lead as the best-performing investment of the 21st century over stock indices and virtually any other long-term investment asset class:
After consolidating its strong run from 2019 to 2020, GLD looks set to resume its long-term uptrend in the near future. In addition, there are several catalysts for accelerating price increases which we will examine later in this article.
#1. The days of the US dollar as the world’s reserve currency comes to an end
Perhaps the main reason we’re bullish on GLD right now is that the US Dollar’s days as the world’s reserve currency are coming to an end.
While the US government’s abuse of its enviable status as the issuer of the world’s reserve currency is evident in the massive and persistent trade and fiscal deficits the country has racked up, it looks like the chickens might finally be coming home to perch.
For example, on February 26, the G7 and the European Union decided to freeze the Russian Central Bank’s foreign exchange reserves in US dollars and euros. Given that 60% of Russia’s international currency reserves are in these two currencies, and that it is such an important nation (a leading nuclear power, a member with veto power in the UN Security Council, a major oil exporter and power broker in the Middle East). While this may have been an effective and relatively painless way to punish Putin in the short term, it could have huge long-term consequences for the US dollar in particular.
While countries around the world (particularly China) have aggressively built up their reserves of US dollars and euros in exchange for exporting hundreds of billions of dollars worth of goods and raw materials to the euro zone and the states States, this new development could change everyone. this. Essentially, the United States and Europe told these countries that they could terminate access to their foreign exchange reserves at any time and break their promise to accept their own currencies from foreign countries in exchange for reciprocal goods and services. This is a huge deal, as central banks around the world hold over US$7 trillion.
Russia has responded to this effort by establishing a floor price for gold on its currency and no longer accepts euros as payment for its exports. As Russian State Duma Energy Committee Chairman Pavel Zavalny said:
Whether they pay either in hard currency, and it is gold for us, or whether they pay as it suits us, it is the national currency.
With the growing economic importance of Asia, the repeated abuse of its own currency by the United States, and the West’s most recent actions towards Russian dollar reserves, the monopoly of the United States dollar as a reserve currency world is in more trouble than ever. If/when China goes to war with Taiwan and the US decides to follow a similar tactic by sanctioning China, things could go downhill very quickly for the US Dollar as the world’s reserve currency. Russia has already rejected it, and China could be very close behind.
#2. GLD remains an excellent portfolio diversification tool
While traditional portfolio theory (as well as Ray Dalio’s All Weather portfolio) viewed bonds as a sufficient tool for diversification against stocks (both bonds and stocks have had only four years of the past 90 years when both declined), this system of checks and balances seems to have broken in 2022:
Meanwhile, GLD has served as a stabilizing force, with year-to-date returns flat. A similar trend emerged in 2020 during the volatility of COVID-19. As the stock market crashed in the wake of the COVID-19 outbreak, GLD held its value remarkably well and significantly outperformed bonds (BND) during the initial chaos and for the full year.
With significant uncertainty about the way forward for the economy – and much of that uncertainty surrounding geopolitical risks and inflation – there is arguably no better portfolio diversifier than GLD, in particular account given the liquidity that GLD offers as well as the ability to trade options against it with liquidity.
#3. Nominal interest rates are unlikely to stay high for long
A third major catalyst we see emerging for GLD in the coming years is that nominal interest rates are unlikely to stay high for long. The reasons are simply:
(1) Sovereign debt and deficits around the world – especially in the United States – cannot service higher interest rates for an extended period of time without wildly unpopular political decisions having to be made. On top of that, with a major geopolitical competition underway with China, the U.S. government will need continued access to cheap debt in order to finance needed investments in defense, technology, and security. diplomacy to stay competitive.
(2) The economy will struggle to sustain higher interest rates, especially given the dependence of businesses and individuals on debt. With the cost of capital so high, growth will likely come to a screeching halt, plunging us into a recession. This will only make the first point even worse and – with the hugely crucial 2024 election fast approaching – there will be immense political pressure on policymakers to cut interest rates by then in the aim of supporting the declining economy.
(3) Related to point 1 as well, the fact that inflation makes the massive US deficit and debt less important, while rising interest rates and the rising value of the dollar make the debt and deficit more daunting. It is therefore very likely that policymakers will opt for higher inflation rather than higher interest rates.
(4) There are massive technological forces at play right now, such as artificial intelligence and machine learning, robotics and other advances that will be very deflationary in nature. If/when these play out more fully over the next few years, inflation rates should come down significantly, freeing up policymakers to cut interest rates significantly while reducing market pressures that are also pushing interest rates up. rising interest.
As the chart below illustrates, with the exception of last year (for the reasons we have already listed), there is a strong correlation between negative real interest rates and rising oil prices. ‘gold.
|Year||Real interest rate||Golden performances|
|2010||Clearly positive||Significant increase|
|2011||Clearly negative||Significant increase|
|2012||Clearly negative||Significant increase|
|2013||Clearly positive||Down strongly|
|2014||Slightly positive||Slightly down|
|2015||Clearly positive||Down strongly|
|2019||slightly negative||Significant increase|
|2020||About zero||Significant increase|
|2021||Clearly negative||Slightly down|
source: author’s calculations comparing CPI, US long-term interest rates and gold price movements
Therefore, given our belief that interest rates are unlikely to rise over the long term, the odds are strongly in favor of a rise in gold prices.
Key takeaway for investors
GLD offers investors an exceptionally attractive risk-reward profile at this time thanks to the severe international and geopolitical headwinds the US dollar will face in the years and decades to come, its ability to serve as an effective portfolio diversifier, and the likelihood that nominal interest rates are likely to remain in a low band over the long term.
Accordingly, we believe now is the time for investors to ensure their portfolio maintains a healthy allocation to the yellow metal, and GLD is arguably the easiest and most liquid way to do so.