In his latest online report, fund manager Axel Merk looks at the ongoing battle between gold and stocks. As many Denver Broncos fans are likely doing as their team heads to Sunday’s Super Bowl against the favored Carolina Panthers, the president of Merk Investments wonders if gold can prove its mettle.
“‘Stocks beat gold in the long run!’ is a ‘rallying cry’ to buy stocks we have heard lately that gets me riled up,” he said. “It’s upsetting to me for two reasons: first, an out of context comparison, in my opinion, misguides investors. [Second,] it might be the wrong assertion in the short to medium term.”
According to Wharton Business School Professor Jeremy Siegel, U.S. stocks had a real (after-inflation) rate of return of 6.7% from 1802 to 2013 vs. 0.6% for gold during the same period.
Year to date through mid-Wednesday, the SPDR Gold ETF (GLD) is up nearly 7.5% vs. a drop of 8.2% for the SPDR S&P 500 ETF (SPY). DoubleLine Funds CEO Jeffrey Gundlach says he thinks gold could hit $1,400 an ounce this year; it traded near $1,140 on Wednesday.
Merk admits that gold is not meant to outperform stocks in the long run. However, like bonds and cash, investors choose to add gold to a portfolio “not because we think they’ll outperform stocks in the long run, but because they may be valuable diversifiers.”
The portfolio specialist says investors need to recall how bonds performed from the end of the Great Depression through August 1979. “That negative performance has a good reason: We experienced an environment of financial repression as real interest rates were negative,” he explained.
Here We Go Again
This is the type of environment that Merk believes is favorable to gold, since receiving no interest is better than negative real rates.
Before 1971, though, gold couldn’t react due to the link between it and the U.S. dollar (“The ‘gold window’ closed because the U.S. could no longer sustain the link; not surprisingly, the period after 1971 was rather volatile and distortions (the boom/bust of 1980) were a side effect,” Merk stated.
As for today, we may be in a period like the Great Depression, he says, since “we are near the end of a debt super cycle.”
This means that after decades of credit expansion, it’s time for a reduction in the relative level of debt in the economy. This usually happens via growth, default or inflation.
“If our analysis is correct, then odds are high that the era of financial repression may well persist for some time, as the huge debt overhang is worked through,” Merk said. “In that context, gold, these days no longer pegged to the dollar, may perform favorably compared to bonds and the dollar. As such, gold may be a good diversifier to a stock portfolio, in the right circumstances.”
It’s within the context of diversification that Merk sees Siegel’s bullish stock stance as possibly “doing a disservice to investors,” he says. “Very few advisers recommend a 100% stock allocation; the reason we diversify our portfolios is because most of us are looking to maximize risk-adjusted returns.”
In fact, the portfolio manager adds, diversification is “the one free lunch that Wall Street offers.”
Though this does not necessarily mean that gold or any other specific asset is the “ideal diversifier … it strongly suggests that touting gold or any asset class as the single best investment may be problematic, unless accompanied by a litany of disclaimers/qualifiers.”