Blue Horseshoe Loves Gold

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Blue Horseshoe Loves Gold

“I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.” That sentence appears at the end of a long LinkedIn post by Bridgewater’s Dalio dated just yesterday, and given his high profile in the investment community it’s getting a lot of attention. Here’s how he comes to this conclusion:

  • Because of low/negative global interest rates and high equity valuations, future returns on financial assets will be much lower than historical norms.
  • At the same time, liabilities like US entitlement programs, pensions, private debt and other government programs continue to climb.
  • That means many owners of capital will eventually have to sell assets to fund those liabilities, pressuring future risk asset returns even lower.
  • This will occur during rising societal tensions due to wealth inequality and global conflicts between countries scrabbling for incremental geopolitical and economic advantage.
  • Against that backdrop the “easiest and least controversial way to reduce the debt burdens and without raising taxes” will be for governments to “continue printing money to pay their debts with devalued money”. Enter gold, with its limited supply and global acceptance as a store of value.
  • You can read the full text here:

Dalio calls these future events a “paradigm shift” from the current order of things and outlines how they tend to come along every decade; that observation sent us to the historical record to see how gold has performed versus the S&P. Even though it has been around for +5,000 years, the modern era really starts in 1971 when President Nixon ended dollar convertibility to gold. The price then was $43/ounce. Here’s how the decades since have treated the yellow metal (chart at the end of this section with annual relative performance to the S&P 500):

1970s – A “Golden Age”: Over the rest of the 1970s gold dramatically outperformed the S&P 500. Gold rose by 947% from year-end 1971 to 1979, while US stocks only rallied by 50%. Moreover, gold was a fairly steady outperformer, beating stocks in 6 of the 8 years after Nixon’s decision.

1980s – 1990s: From Hero to Zero: Gold, however, languished for the next 2 decades (1980 – 1999), only outperforming the S&P 500 in 3 years: 1986, 1987 and 1993. At the start of this period (December 1979) gold traded for $455/ounce; by the end (December 1999) it was just $283/ounce. The S&P 500 rose by 2,500% (not a typo) over the same 20 years.

Early 2000s: Gold’s Redemption: Things brightened for gold from 2000 – 2009, and it outperformed US stocks in 8 of 10 years. The S&P 500 was down 9% but gold went from $283/ounce in December 1999 to $1,135/ounce in December 2009, a 304% gain.

The last decade: Another bad one for gold relative to stocks. The S&P rose by 169% from 2010 – 2018, but gold only advanced by 10%. That trend continues this year, with the S&P up 19.5% but gold only 12.6% higher.

Verdict: Dalio’s heuristic of decade-long paradigms does seem to hold when it comes to the relative performance of gold versus stocks. And we are coming off a “bad” decade for gold, so reversion to the mean may well be a tailwind for his call.

There is also the question of how much gold can rally over a given year, so to answer that question we looked at rolling 12-month price changes back to 1980. Another chart below, and a few brief points:

  • The average annual gain for gold is 3.2% over the past 39 years, with a standard deviation of 16 points.
  • During the last decade when gold rallied (2000 – 2009), its average annual return was 14.2% with a standard deviation of 14 points.

The upshot here: assuming Dalio’s “decade paradigm” holds, gold’s price action for the next 10 years should resemble its last bull run rather than the long-run averages. Forgetting for a moment that 2019 has already seen a 13% advance for the yellow metal, that means:

  • A reasonable 1-year price target for gold is $1,652/ounce, up 14.2% from today.
  • Looking out a decade and using the same bull market average advance yields a price target of $5,460.

Final thought: global central banks (Russia and China, mostly) have been large buyers of gold over the last 18 months, and Dalio’s analysis is both a reasonable explanation for this AND gives a hint as to why he is confident enough to make his call now. Gold pays no dividends, so its financial value is purely as a dollar hedge. Central banks are therefore a natural buyer, and they have begun increasing their holdings but have plenty more firepower to add to this trade. As do many other asset owners, who have underweighted gold due to its now-decade long period of underperformance.