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Stocks vs. Gold: The Financial Tug of War Continues
On the Friday after Thanksgiving, the U.S. stock market closed at another all-time high of 2,213 on the S&P 500, 5,399 on NASDAQ and 19,152 on the Dow Jones Industrials. Meanwhile, gold declined once again to $1,180 after peaking overnight (on election night) to $1,335, a decline of over 10% in 17 days.
At times like this, it’s important to remember that gold and silver are still outperforming stocks in 2016. Through November 25, the Dow is up 9.9%, the S&P is up 8.3% and NASDAQ is up 7.8% for 2016 to date, but gold is up 11.4% and silver is up a whopping 19.5% in 2016, so it’s profitable to own…both!
Unlike many gold marketing firms, we at Navellier Gold have always recommended investors maintain a majority position in well-selected stocks, with only a small (perhaps 10%) position in physical gold and silver coins and bullion. We never try to warn investors about a “coming crash” in order to motivate them to buy gold. The main reason we own gold is for portfolio balance. History shows that gold tends to “zig” when stocks “zag” and vice versa. If you need any further proof, look at the 2016 election results!
First, a humbling admission. We were among many other gold analysts that predicted gold could possibly SOAR following a surprise Trump victory. On the evening of the 2016 election, we looked like geniuses as gold soared to $1,335 around midnight, when it became apparent that Trump would win. At the same time, the Dow’s futures retreated over 800 points, but those two trends reversed in morning’s light, when the stock market began to feel good about the Republican’s sweep of Congress, creating hope for positive changes in tax policies, economic growth, fewer regulations and more jobs in infrastructure and energy.
Stocks and gold have continued to move in opposite directions since the election. Here is a comparison of the S&P 500 index and gold from the Friday before the election to the day before Thanksgiving, 2016.
Gold and Stocks Tend to Run in Opposing 20-Year Cycles
On January 21, 1980, the day gold reached $850, the S&P 500 traded at 112, or just 0.13 times as much as an ounce of gold. The Dow Jones industrials nearly touched gold’s price, at 872, creating a slim ratio of 1.03 to 1. Twenty years later, on the Dow’s peak day (at 11,723), Dow’s ratio to gold was over 41-to-1.
The following chart shows the wide swings between gold and stocks since 1928.
This is a semi-logarithmic chart so it tends to limit the amplitude of the extremes, but the extreme highs and lows in the stock/gold ratio – taking place in 1980 and 2000 – represent a swing of more than 41-to-1 (over 4,000%) in comparative valuation, a shocking swing from overvalued to undervalued valuations.
Turning to more modern times, since Labor Day weekend of 2000, gold us up 326% vs. only 45% for the S&P. Gold was severely undervalued and stocks were overvalued then, but on September 6, 2011, gold peaked at $1,895 (on the London pm fix) while the S&P 500 was only 1,165, so stocks were undervalued. In the 5+ years since then, the S&P 500 stock index us up 90% while gold has retreated by almost 38%.
The best recent time to buy gold was on December 17, 2015, when gold traded at $1,049 following the Federal Reserve’s 0.25% increase in short-term interest rates. That put the S&P 500-to-gold ratio at 1.95.
However, with gold’s recent downdraft and the rise in most major stock indexes to all-time highs, today’s investors have another superb buying opportunity, since the current S&P 500-to-gold ratio is at 1.88.
Speaking simplistically, gold is a bargain when it trades at a price below the current S&P 500 index. By contrast, stocks are a relative bargain when the S&P 500 trades below the price of an ounce of gold. With the S&P/gold ratio currently at 1.88, we may see several more years of gold’s relative outperformance.
However, it is important to always retain a majority position in stocks, along with a minority position in gold, since nobody can predict the future accurately – as we have clearly seen this November!
A Second Tug-of-War: Paper Gold (ETFs) vs. Real Gold
After the surprising election outcome, several major hedge fund managers have begun unloading their shares in the leading gold exchange-traded funds (ETFs). Unlike owners of the real thing (physical gold), these “paper gold” investors can buy and sell their gold ETFs quite easily, with the click of a mouse on their desktop computer. By contrast, holders of real gold tend to be “strong hands” (long-term investors).
Due to the leverage available in gold ETFs and futures contracts, hedge-fund gold investors have become the “tail that wags the dog” in the gold market. After the election, the momentum clearly switched from gold to stocks, generating massive sales of gold ETFs by big funds. For instance, Stanley Druckenmiller, the founder of Duquesne Capital, said he sold all his gold on election night. He later told CNBC that he’s optimistic that Trump will bring deregulation and “serious” tax reform, which will stimulate the economy.
Hedge funds are required to report their holdings to the Securities & Exchange Commission (SEC) 45 days after the end of each quarter. On November 14, therefore, we learned that Soros Fund Management sold all of their 240,000 shares in SPDR Gold, the largest gold ETF, during the third quarter. At the same time, Soros raised its position in Barrick, the world’s largest gold producer, from 1.07 million shares as of June 30 to 2.85 million shares as of September 30, 2016. Another major hedge fund involved in the gold market, Paulson & Co., said it retained all of its 4.78 million shares of SPDR Gold during last quarter.
We likely saw a lot more gold ETF sales in November. There was net selling of gold in the ETF vaults for 10 straight trading days after the election. With a few days left in November, we are already on course for the biggest monthly decline in ETF gold since 2013. In addition, according to data from Bloomberg, 85,500 gold futures contracts, worth over $10 billion, have been sold so far in November.
These momentum players are betting on a stronger U.S. dollar, which tends to depress the price of gold. They also foresee a series of interest rate increases by the Federal Reserve this December and throughout most of 2017. Any such rate increases would tend to make the U.S. dollar even stronger, since the dollar will offer rising income in a strong currency vs. negative (or near-zero) interest rates in Japan and much of Europe. Many traders also see a coming recovery in the stock market based on the pro-business and low-tax policies of the Trump administration and the Republican control of Congress (and most states).
They may be right, but reality has a way of confounding the best-laid plans of any new President after his early “honeymoon” with Congress. After the new President takes the oath next January 20, we’ll see how quickly the President and Congress can engineer these reforms in the tight window of the first 100 days.
We must also consider gold’s role as a crisis hedge. Will North Korea or Iran or ISIS or China or Russia (or some rogue foreign power) seek to test the new, heretofore-untested President. We’ll see how well the new administration responds to any severe external threats. We are also likely to see a rebirth of inflation under Trump’s policies, as well as higher interest rates coming from the Fed, due to a stronger economy.
Two leading Wall Street firms see higher gold prices from inflation, despite the odds pointing to higher interest rates in 2017: Goldman Sachs’ chief global equity strategist, Peter Oppenheimer, advised clients to sell government bonds and buy gold because of an expected rise in inflation resulting from Trump’s stated policies. In addition, BlackRock Global’s Head of Asset Allocation, Russ Koesterich, sees says the Fed’s interest rate decisions in December (and in 2017) “will be “driven by changing perceptions of inflation.” For this reason, they say, “higher interest rates may not be an impediment for gold.”
Even though a stronger dollar could mute gold’s gains in U.S. dollar terms, the negative interest rate environment in Europe and Japan could cause a major run toward gold there. With a weaker euro, the price of gold could rise sharply in euro terms. If so, this should fuel continued European demand.
Two European-based banks are positive on gold – even after the price collapse following the election. UBS Wealth Management Research says they expect gold will be back to $1,350 within six months, and HSBC’s James Steel said strong Chinese buying will provide support for gold and limit gold’s downside.
Central banks are also buying gold. According to the World Gold Council (WGC), central banks bought 81.7 metric tons of gold in the third quarter, bringing the nine-month 2016 total to 271.1 metric tons. Juan Carlos Artigas, director of the WGC’s investment research, said that a recent WGC survey of 19 central bank managers found that 17 of them (nearly 90%) plan to either increase or maintain their gold reserves.
With gold buying in Europe and Asia providing a floor under gold, any reversal in the dollar’s fortune, or setbacks to the expected reforms under the new Trump administration, we should see gold revive in 2017.