Humans have been using gold as “money” for thousands of years.
What is money? No, it’s not the root of all evil – that’s love of money (1 Tim 6:10). Money is something generally accepted as a medium of exchange for goods and services. For my purposes, it is virtually the same as “currency,” although you can easily find people who will tell you that money and currency are two different things or ideas. But that is a whole different commentary.
There is good money and bad money. It isn’t all created equal. Some say that what gives the US dollar its value today is the strength of the US military. All I know is that the value of the dollar doesn’t come from our pristine balance sheet which shows that the country is deeply in debt and getting worse by the minute.
The dollar used to be backed by gold. For every dollar in circulation there was once a specific amount of gold in a safe somewhere (Fort Knox). Every dollar used to be worth 1/35th of an ounce of gold – and each ounce of gold was fixed at $35/oz. This meant that the only way to print new dollars for circulation was to find more gold reserved.
For example, if you had 1,000 ounces of gold, and you fixed the price at $35/oz., you would have $35,000 in circulation. And each dollar would be worth about 8 grams of gold (0.285 ounces or 1/35th an ounce).
This was a great idea for many reasons, one of which is that a dollar bill weighs about 1 gram, so it was almost 90% lighter than carrying around the same value of gold. It lightened the burden while maintaining the value. As long as you trusted that for every dollar there was indeed a specific amount of gold you could go get if you wanted to.
If you printed another $1,000 dollars without putting another 28.5 ounces of gold in the safe, there would no longer be enough gold to back the $35/oz. price and the price of gold would rise to $36/oz. Meanwhile, the inverse fact is that the value of the dollar would concurrently fall. Instead of each dollar being worth 8 grams of gold it would fall to about 7.8 grams.
By 1971 there wasn’t enough gold in America’s reserves to cover the number of dollars in circulation and this caused people to rush to convert as many dollars to gold as they could before the reserves ran out and President Nixon declared the suspension of the dollar’s convertibility into gold.
Our currency hasn’t been backed by gold, or anything else as far as I can tell, for many decades now. And of course, Gold is nowhere near $35/oz.
Never trust a politician… especially as it relates to printing more currency than they should.
The characteristics that have made gold a currency for thousands of years are the same that will keep making it a currency for thousands of years more. There are 5 core attributes of gold that make it money. They are:
Scarce: only about 200,000 tonnes of gold has been mined in history. For context, if you melted this all down you could pour it all into just two Olympic sized swimming pools.
Fungible: one ounce of gold is no different than another ounce of gold. Same as one US dollar is no different than another US dollar.
Divisible: gold can be easily divided into smaller units without losing its (per ounce) value. Just like 4 quarters equal one dollar.
Durable: gold is the least reactive of all metals. It doesn’t rust, tarnish or perish. Ever.
Portable: this one is interesting because while you can easily transport gold from one place to another, it is very heavy… as an aside, Bitcoin is a form of “digital gold” that weighs nothing.
Over thousands of years gold has maintained its purchasing power better than any other natural commodity or man-made creation. What I mean by purchasing power is that if you exchanged an ounce of gold for dollars today, you could take those dollars to buy about the same amount of any item as you could have a thousand years ago, a hundred years ago, or ten years ago. A good example is contained in the old saying that “an ounce of gold can buy a nice men’s suit.” Back when gold was $35 an ounce, it would have bought a very nice suit. Today at $2,330/oz it would buy a very nice suit. It’s not bad as a rule of thumb for my purposes today.
And what is my purpose today, you ask?
Here goes…
My point is that gold is not supposed to be a growth investment. In fact, gold is a choice not to invest. Gold does nothing, produces nothing, generates nothing. It is inert. It stores value and that is it. This is perfectly fine. It shouldn’t do anything. Gold’s value comes from its ability to measure the value of other things, including dollars. As the US dollar depreciates (due to more and more being printed) it takes more dollars to buy an ounce of gold. It’s not like stock in a company that becomes more valuable when the company sells more widgets or provides more services and increases profits over time.
At Elevate, we often refer to gold as a “chaos hedge.” This means that when there is chaos in the markets, gold’s stability is highly desirable. You’ve probably heard us say that if our gold position (usually 5% or less) went to zero it would be a great thing! Why? Well, because if gold goes to zero it means everything else we owned probably increased in value by A LOT – more than making up for losing 5% of our portfolio in gold. And by contrast if gold goes up a lot, it’s probably not a great thing. It probably means that there is chaos in the markets and that usually means stocks are down.
So, with that in mind, what if I told you that gold is up big in 2024?
You should rightly assume that markets were probably down, perhaps down big.
Well, as you can see in the chart below, as of the end of May, gold is up more than both the S&P 500 and the Nasdaq in 2024 during a melt-up bull market.
What does that tell us? It is disconcerting, to say the least.
Aside from telling us that the market is broken, and misbehaving pretty much across the board, it tells us that there is a lot of demand for gold.
But where is that demand coming from? Is it traders, speculators, and retail investors?
Nope.
If it were, you’d see new shares of gold ETFs being issued and the number of shares outstanding rising with the price of gold as has always been the case since the ETFs came into existence.
It should be no surprise that when gold is rising people buy the biggest gold ETF in the world (GLD) and the number of shares increases, and then when the price of gold starts falling those same people sell their shares causing the number of shares to fall.
But that isn’t happening today – in fact, the opposite is happening for the first time ever. Shares outstanding in GLD have actually fallen during this gold rally.
A closer look will reveal that the demand for gold is coming from central banks around the world that used to be happy to hold US Treasury securities in their reserves but now prefer gold. They don’t want to buy or even hold our debt anymore. With nearly $35 trillion in national debt, I can’t say I blame them.
And it isn’t just that the US is effectively bankrupt, we are also weaponizing the dollar in ways we haven’t in the past. In response to the Russia/Ukraine conflict, the Biden administration froze around $300 billion of Russian holdings in US Treasuries. And a couple months ago, there was a bill passed in the US House of Representatives that would allow the administration to permanently confiscate that money and… if you can believe it… give it to Ukraine.
I wish I were making it up.
This could lead to higher interest rates than anyone currently thinks possible for longer than anyone currently thinks possible – pretty much no matter what the Fed does with the overnight lending rate.
The only way to attract buyers is to pay a higher interest rate.
The United States can’t even afford the current levels of debt at current interest rates let alone greater levels of debt at even higher interest rates. The writing is on the wall.
Gold is calling this situation out. So is Bitcoin for that matter. Thankfully, we own some of both in our core strategies, and we probably always will.
How high can gold go? Your guess is as good as mine, but one way to do the math is to consider how much of our currency the government would have to back with gold (returning to a form of the old ways under the Bretton Woods system) in order to stabilize the currency and keep the dollar’s status as the primary world reserve currency. It would be a new “gold standard” that we abandoned under Nixon where anyone holding a dollar could freely exchange it for some amount of gold. For reference, 40% was the legal requirement for the Federal Reserve from 1913-1946.
Then you compare that to the total number of dollars in circulation, say, using M1 money supply.
If you consider that as a country, we currently have about 261.5 million ounces of gold in reserves, without acquiring more (which we cant afford to do at any price) the implied price of gold is found by taking the money supply x the percent backed by gold / the amount of gold we have in reserves.
For example:
17.9 trillion (M1) x 40% (backed by gold) / 251.5 million ounces in reserves = Gold price of $27,380/oz.
Now, I am not saying that I really think that gold will go to $27,000/oz. any time soon, or even at all. It actually sounds crazy. But I think if you told people in 1965 that gold would be trading at $2,300/oz. today, or if you told me in 2023 that gold would be up more than the Nasdaq in 2024 in the midst of AI bubble mania, they and I would have told you that you were crazy!
So, as I often say, I don’t predict, I prepare. And I prepare for a wide range of outcomes.
In May, markets staged a nice recovery from the April pullback putting in fresh all-time highs before falling slightly into month-end.
Here is a look at the indexes we’ve been tracking for the past several months and below that you’ll see where they are all sitting for the year 2024, through the end of May.
You may notice I added bonds to the chart. Sort of shockingly, the aggregate bond market is on track to be down for the third out of the past four years.
With the S&P 500 up about 10% and bonds down about 3% this year, a simple 60/40 portfolio is up only about 4.8% in 2024. A more diversified portfolio using the equal-weight stock index is up even less.
Today is the 20th anniversary of my 21st birthday, and all I got was fresh inflation data and a Fed Meeting… Just kidding, I got a lot of love and gifts from my friends and family too – the economic data was a bonus!
The Consumer Price Index (CPI) for May was reported at 3.3% this morning and the Fed decided to leave interest rates alone at their meeting. The Fed thinks interest rates are restrictive enough to bring down inflation. I find that hard to believe given that we are still 130 basis points (1.3%) higher than their stated objective – but what do I know?
While the inflation data was slightly lower than expected, a positive development, the Fed also released its quarterly “Summary of Economic Projections” or SEP, which includes the famous “dot plot.” The dot plot shows where each Fed governor thinks interest rates will be at various future dates and receives a ton of attention from Wall Street economists, for better or worse.
The prior dot-plot showed that, on average, the Fed expected three rate cuts of 25 basis points (bps) each, before the end of 2024. Despite the slightly better than expected inflation data, today’s dot-plot shows only one cut of 25 bps. I continue to expect zero cuts this year, absent a recession and substantial drop in the stock market.
For now, the market keeps chugging along, even if the gains are more highly concentrated in just a few big stocks than ever before. It is getting more and more difficult to find companies trading at reasonable valuations and with the return of “meme stocks” that deserve to be bankrupt (and will probably end up that way eventually) it is starting to feel a lot like 2021 - when GameStop and AMC Theaters were the best performing stocks in the market.
This action can go on for longer than anyone thinks possible – as always. But we know how the story ends. Even I am old enough to remember how the inexplicable 2021 rally ended with 2022 seeing stocks drop bigly, including even stocks like today’s AI darling Nvidia falling 65%.
Make no mistake – there is no reason that can’t happen again. I assume it will. The only question is when. Until then, we will stay aggressively long while following our rules-based exit strategies to get out when things inevitably turn south.
There is always more I wish I could write, but I know your time is important and I don’t want to bore you any further! Before I finish, one item of housekeeping.
New Portal
As I mentioned last month, we have made some changes to our technology providers, and you will lose access to your current performance portal on July 1st. It has been replaced with a new one and if you haven’t already received an invitation to login, you will in the next couple weeks. We hope you’ll enjoy the new platform!
Until next time, I thank God for each of you, and I thank each of you for reading this commentary.
Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio performed vs. the markets last month.
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisors
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