Uncertainty around the world is rising. And while that makes investing more difficult, it also creates opportunity.
With worries building up around the U.S.-China trade war… its knock-on effect on an already slowing Chinese economy… a potential slowdown in the U.S. economy… and a prolonged U.S. government shutdown, stock markets around the world have fallen.
Last year, the S&P 500 Index fell 5.7 percent while the MSCI Asia ex Japan Index dropped 14.5 percent. Singapore lost 8.8 percent, Hong Kong fell 11.7 percent and the Shanghai Composite Index collapsed 26.4 percent.
But there’s one asset that has held up relatively well in the face of these widespread declines. That’s gold, which saw its price fall just 0.9 percent in 2018.
Gold is a friend in times of uncertainty
For centuries, an ounce of gold has purchased the equivalent of a fine men’s suit. It still can today.
That’s because gold is an economic constant. Never will it become worthless. It will never wither away from the decay of inflation over time like a fiat currency.
Gold carries no risk of default, unlike a bond, nor can it go bankrupt, like a company.
So when stocks fall, gold tends to hold its ground (or go up). It’s great portfolio insurance.
For instance, gold tripled during the 1973 Arab oil embargo that caused the U.S. stock market to crash and the economy to go into recession.
It quadrupled in the late 1970s as inflation soared to double-digits, leading to then-Fed Chairman Paul Volker raising prime lending rates to a historic high of 20 percent.
During the dot-com boom, gold fell out of favour, but came roaring back after the tech bubble burst and the U.S. economy went into a recession. Gold rallied 5.3 percent from March 2001 through November 2001.
More recently, during the global economic crisis, the S&P 500 fell 56 percent from peak to trough between October 2007 and March 2009. Gold gained 25 percent during the same period.
When global markets fell late last year, investors once again turned to gold. Its price rallied 5 percent as stock markets fell across the board.
And I believe gold prices could rise more this year.
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The gold-to-S&P 500 ratio remains high
Because of gold’s proven ability to hold its value, and even rise, during turbulent markets, it’s been used as one gauge of how expensive (or cheap) the stock market is.
The measure is called the gold-to-S&P 500 ratio. It indicates how many ounces of gold it would take to equal the S&P 500 index at any given time.
For example, if the S&P 500 index closed today at 2,560 points and the current price of gold is US$1,200, then the gold-to-S&P 500 ratio would be 2.13.
The higher the ratio, the more ounces of gold it takes to equal the S&P 500 index. A high ratio, therefore, indicates an expensive stock market relative to gold.
The chart below shows that the ratio has hit three major highs in the last 90 years.
Even after gold’s recent year-end rally, the gold-to-S&P 500 ratio is still above 2. That’s lower than the past two peaks, but still high on a historical basis.
Looking at gold this way, it has more room to rise than fall.
But there are two other reasons why gold should continue rising this year.
1. China is buying
China was already the world’s largest buyer of gold at 1,089 tonnes in 2017. It was on-track to increase purchases at least another 5 percent in 2018.
It’s the world’s largest buyer for two main reasons.
First, the Chinese have a cultural affinity for gold, which they view as auspicious for important events (like weddings, birthdays and New Year’s celebrations).
Second, the Chinese government has been buying up increasing amounts of gold to diversify away from the U.S. dollar. China’s official central bank holdings of gold grew from 1,054 tonnes at the start of 2015 to 1,843 tonnes by the second quarter of 2018.
That’s the second-largest increase in official central bank gold reserves during this period (Russia was first), and the 789-tonne increase alone is equivalent to the entire gold reserves of Japan’s central bank.
In the first three quarters of 2018, China’s official gold consumption reached 850 tonnes of gold – a 5 percent year-on-year increase. This includes gold purchases by individuals, as investments and jewelry, as well as by industry and the central bank.
Consumption jumped 14 percent in the third quarter alone, which indicates China has been accelerating purchases during periods of weakness in gold prices.
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2. Gold ETF holdings are rising
The creation of the first U.S.-listed exchange-traded fund (ETF) backed by physical gold, the SPDR Gold Trust (Exchange: New York; ticker: GLD), back in 2004 revolutionised the way gold was bought.
It allowed ordinary investors to own and trade gold just like a listed stock for a minimal fee.
Since then, the popularity of gold-backed ETFs has exploded.
During the peak of gold prices in September 2011, gold-backed ETFs controlled nearly 2,400 tonnes of physical gold. That was larger than most countries’ central bank gold reserves.
As of the end of 2018, the total gold held by gold-backed ETFs amounted to 2,440 tonnes. That was a net increase of 75 tonnes from the previous month, and the third straight month of increased gold holdings.
These increases coincided with the downturn in global stock markets, particularly for the U.S.
And with stock markets still seeing volatility, more and more investors will likely turn to gold-backed ETFs.
2019 could be big for gold
As we said earlier, gold tends to go up as stocks go down (thanks to its negative correlation).
Gold has already been marching higher for months. And the recent three-month streak in ETF gold-buying is an indication that investors are starting to pay attention to gold.
If another crisis comes along, gold is going to be a backstop for investors. And those who already own it will have taken an early step to mitigate potential losses in their portfolios.
So now is a good time to add some gold to your portfolio through an ETF like the SPDR Gold Trust (Exchange: New York Stock; ticker: GLD; Exchange: Singapore; ticker: 087) or the Value Gold ETF (Exchange: Hong Kong; ticker: 3081).
Edtior, Stansberry Pacific Research
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