A volatile beginning to 2015 is helping gold to regain some of its mojo. The U.S. stock market got off to a shaky start in January, and instability in currency markets initially lifted the price of gold bullion.
The SPDR Gold Shares (GLD) is already up around 7% year-to-date. Likewise, ETFs that leverage exposure to gold and related assets like the ProShares Ultra Gold ETF (UGL) and the Direxion Daily Gold Miners Bull 3x Shares (NUGT) have soared 14.6% and 72% respectively.
A swift decline in the euro and the recent move by the Swiss National Bank to end the cap on the franc are reminders that currency values can change dramatically. Will Denmark be forced off its krone peg to the euro as well? Amid recent currency ups and downs, gold looms as an alternative.
Although the global trend in monetary easing in Asia and Europe, with central banks buying up sovereign debt, has kept markets afloat, there’s still great interest by bankers in owning precious metals. Net purchases of 92.8 tonnes in Q3 2014 brought net purchases to 335 tonnes, slightly higher than the same period of 2013 (324 tonnes), according to the World Gold Council. Central bankers around the globe are still diversifying into gold.
Curiously, bankers’ enthusiasm for gold hasn’t been matched by investors. Despite central bank buying, demand for gold ETPs got progressively worse throughout 2014, falling 2.6% in Q1, 39.9% in Q2, and 41.3% in Q3. Why has gold sentiment been so negative?
“Since December 2012, gold’s relative strength momentum has been near the bottom of the universe we track made up of U.S. equity sectors, non-U.S. equities, bonds and real estate. In fact, gold has ranked dead last in 19 of the past 21 months,” said Gary Antonacci, author of “Dull Momentum Investing” (McGraw-Hill, 2014). “Given the high volatility and potential risks of the gold market, investors would do well to hold gold only when its relative strength momentum is strong or at least rising.”
Consider the relative performance of gold last year against major asset classes like stocks, bonds, and real estate. Only developed international stocks (VEA: –5.98%), commodities as a group (GCC: –11.05%) and bitcoin (–56%) performed worse than gold (–2.19%).
Regardless of gold’s underperformance in 2014, some advisors have used recent weakness in precious metals to strategically capitalize.
“Gold and silver are both interesting potential long-positions, but they can be extremely volatile at times. We traded silver (SLV, AGQ, USLV) recently, and quickly sold our position. We do not have any exposure to precious metals currently, but we are watching them both closely,” said David S. Kreinces, portfolio manager at ETF Portfolio Management in Thousand Oaks, California.
Aside from GLD, the largest gold ETP on the planet ($31 billion in AUM), there are other ways to obtain exposure to bullion.
The ETFS Physical Precious Metals Basket Shares (GLTR) offers a 4-in-1 solution by simultaneously holding exposure to physical gold, silver, platinum and palladium. GLTR eliminates the guesswork of deciding which among the precious metals will be the best performer by owning all four. Some advisors are using GLTR to maintain diversified core exposure to precious metals versus holding one metal.
The Market Vectors Gold Miners ETF (GDX) and Junior Miners (GDXJ) are two other ways to obtain exposure to gold, albeit in indirect exposure via mining stocks. Historically, mining stocks have been twice as volatile as gold itself. Despite the high volatility, some advisors choose equities because of more favorable tax treatment compared to gold’s 28% long-term capital gains rate.
Leveraged long and short ETFs are strategic short-term trades that offer another way to capitalize on movements in gold.
Aside from the earlier mentioned bullish funds (UGL and NUGT), the ProShares UltraShort Gold ETF (GLL) and the Direxion Daily Gold Miners Bear 3x Shares (DUST) offer inverse exposure to gold and mining stocks for bearish traders and investors. GLL offers double daily opposite exposure to gold while DUST aims for triple daily inverse exposure to mining stocks.
Generally, 2x and 3x leveraged ETFs are best used in markets where the underlying asset is sharply trending in a certain direction.
One of the biggest myths promoted over the past several years is that massive monetary stimulus by the U.S. Federal Reserve Bank (also known as “quantitative easing” or “QE”) was a bonanza for gold. With global central banks imitating the Fed, this is also the same view about gold being promoted today. What does history show?
Gold scored its biggest gains from the first round of QE, with a 35.66% pop. But thereafter, gold’s performance for each successive round of QE substantially decelerated. In fact, gold’s gross gain of 45.76% during QE1 and QE2 was nearly been wiped out by its 32.91% loss during QE3.
Furthermore, the relative performance of U.S. stocks versus gold during these three periods of QE gives a realistic view of gold’s relative performance.
During QE1, the SPDR S&P 500 ETF (SPY) gained 34.51%, in QE2 it gained 12.07%, and in QE3 it soared 46.16%. Not only did SPY beat gold’s performance during two out of three QE periods, but the S&P 500′s collective gain of 92.74% for all three rounds of QE easily outdistanced gold’s net gain of just 12.85%.
Not even the performance of long-term U.S. Treasuries (TLT), which the Fed actively bought during QE, comes close to matching stocks. TLT lost 11.22% during QE1, it lost 4.38% during QE2, and recorded a small gain of 3.88% during QE3. Put another way, the U.S. stock market—not gold—was easily the biggest beneficiary of QE.
“All fiat currencies have eventually disappeared, but gold has been around as an asset for 5,000 years,” argues Daryl Montgomery, author of “Inflation Smart: Profitable Investing When Money Devalues” (2012). “Even today, only people in Western countries have faith in paper money. This has never happened in India, China, Russia, the Gulf oil states or in any developing economy.”
Instead of doubling down on a weak euro, Montgomery says that Europeans should be adding to their purchases of gold because of what happened in Switzerland and the current problems in Greece. He thinks the euro could devalue much further.
What about upstart competitors to gold like bitcoin? Will they hurt gold demand?
“People do use bitcoin as an alternative to gold, but bitcoin, like all paper money in the world, is not backed by any hard asset, nor is there any tax authority behind it,” said Montgomery. “Essentially, it is a fiat electronic currency without much of a track record. It is also extremely volatile, more volatile than any paper currency, something most investors don’t like.”
In the end, gold will have its fans and its detractors. But if it holds up the same way it did in 2008 during whatever upcoming shocks surprise financial markets, gold can easily regain its luster.