Feb. 2016 – Stocks, Negative Interest, and Gold

As of mid-February stock markets were continuing to fall. Many culprits — tumbling oil prices, central bank distress, and domestic U.S. politics just to name a few – have been cited. While there are many contributing factors, there is no “cause and effect” that is clearly apparent.

What is apparent, however, is that gold is once again serving well as a form of portfolio insurance. As of mid-February the gold price had increased nearly 14% from its year-end close while the S&P 500 was down 7.4%. There is no guarantee that gold will be a panacea during times of financial duress, but as we have documented1, when capital markets have fallen dramatically, the gold price has often appreciated.

Throughout the globe, gold is considered a form of money that competes with sovereign debt (government notes and bonds) as a safe haven asset. But gold, unlike bonds, produces no income. Now that nominal interest rates in developed nations have turned negative, the opportunity cost of holding gold has diminished, perhaps pushing demand higher.

While we do not know whether these conditions will persist, negative interest rates are not unprecedented, nor do negative interest rates reflect irrational behavior on the part of buyers. U.S. investors have accepted negative real interest rates on U.S. Treasuries for several years now. It might seem that holding cash would make more sense than lending money at a negative rate of interest, but cash can be lost, stolen or destroyed, while holding it in a vault is costly. Treasuries avoid these costs and are widely considered free of credit risk. Negative real rates simply imply that this protection is currently valued so highly that investors are willing to buy these bonds at a price that exceeds their redemption value.

Many investors consider gold a safe haven that is distinct from cash or Treasuries. Gold bullion coins, bars, or shares of gold ETFs are all used for this purpose. Gold ETFs have quickly become popular because these securities, unlike physical gold, are highly liquid. Others, however, prefer physical ownership of the metal. This is a matter of personal preference.

Many financial economists dismiss gold as an unproductive commodity with no expected return. We understand this rationale. But we are also aware that gold has proved its worth during several severe financial crises since John Maynard Keynes decried the gold standard as a “barbarous relic” in 1923. The most recent instance was during the great stock market collapse of 2008-2009.

Gold is also derided becauseits price is highly volatile. This is undeniable; but because its price is not strongly correlated with conventional financial assets, it can moderate swings in a portfolio’s value.

Financial planning is often focused on meeting investors’ long term financial objectives, such as a desired level of income in retirement, or perhaps a future legacy to be left for heirs. But it is equally important to avoid anxiety along the way. Financial theory is an indispensable tool, but it should not overshadow the ultimate goal, which is lifetime peace of mind among our clients and readers. We listen closely, and we have no doubt that gold goes a long way in helping them sleep at night.

Also This Issue:

Recent Equity Returns in Historical Perspective
Investment Research: How We Go About our Business
The High-Yield Dow Investment Strategy
Recent Market Statistics 
The Dow-Jones Industrials Ranked by Yield
Recommended Investment Vehicles