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Gold Begins Outperforming US Stocks And Bonds. New Investment Ball Game. Are You Ready?

 “A lethal combination of budget deficits and trade sanctions are going to be reflected in increasing price inflation for the US. And where the US goes, the rest of us follow.”

Alasdair Macleod

“The Fed Thinks It’s Fighting Inflation. Think Again. Even at more than 5.25%, the central bank’s short-term interest-rate target might not be high enough to cool the economy.”

Bill Dudley, Former NY Fed President and Goldman Sachs Chief Economist

“If you don’t own gold you know neither history nor economics.”

Ray Dalio, Founder of Bridgewater, one of the biggest hedge funds of all time.

 

How strong do you think the US economy really is?

the gov’t is basically “buying” GDP w/ debt, but getting only 50 cents on the dollar – worst deal ever…

Excess policy stimulus is generating inflation, distortions, and weak long-term growth. The emerging trends are a small business depression, with a big business engineered bubble. The engineering is unsustainable.

Investors need to get real clear about how that impacts your portfolio and what you need to do.

First recognize that the bond bubble has broken.

In January 2021, before the Fed had even raised rates from zero, I wrote a blog entitled “The most reckless Fed Ever”. How they could not have seen the inflation they were creating remains incomprehensible to me. Today, although not as extreme, it is becoming clearer by the day that the Fed is once again missing the mark on inflation. This time the bond market is better prepared, even if current allocations suggest investors are not.

The Chart below shows that 10-year Yields have not only broken the 40 year downtrend, but also they are now in a confirmed uptrend reaching for new highs.

Last week’s blog showed that Gold has still not replaced bonds as a significant part of investment advisor’s portfolios as measured by ETF GLD share holdings. Clearly this is also the case with family offices holdings which also show just 1% in each of gold and commodities. This is more a rounding error rather than an allocation.

Excess Stimulus generates inflation, distortions, and unproductive weak growth.

Since the beginning of 2022, both 10 Year Treasuries and the Russell 2000 have produced negative returns for a 2 ½ year period. Yet gold has rallied by over 29%. This is not the result you get from a strong economy with low inflation.

 The repeating result of policy in the US economy, for the last 70 years, is accelerating intervention and excalating debt. “Ironically” this has only produced a continuous decline in long term real growth.

The core health of an economy is how it impacts the small business sector which is where most of the jobs and widespread prosperity is created.

When you examine smaller sized companies you find an escalating depression, and underperformance. In the Russell 2000 over 40% of the companies fail to make any profit. Losses have been in a rising trend for the last 30 years!

Even the profitable small companies are now facing declining profit margins.

While big caps benefit disproportionately from the massive policy interventions, very little benefit goes to small companies. It is clear that they are disadvantaged relative to big companies. Profit margins have halved and are now near recessionary levels.

All the stimulus measures of money supply growth, excess liquidity, and easy financial conditions seem to reach just big companies. Big companies, often don’t seem to need any support as they have around 1 Trillion dollars to spend each year on buybacks to boost their share price, and easy financial conditions to do any financing.

US equity performance reflects engineering big company stock prices, not just earnings, see the chart below.

The widening cumulative gap between the real S&P 500 and real profits is raising concerns about the formation of a new bubble in the stock market. The chart below shows how, in the past, this has created instability through an ultimate stock market correction.

Who cares about these trends? For the time being policy supports wall street, executive stock compensation and most people believe higher stock prices means the economy is fine. The short term incentives are to continue “stimulus” forever at ever greater scale, even if intervention is overwhelming natural economic function and destructive for medium and small companies, and obviously unsustainable in the long term.

However, long term investors need to think carefully. On a cumulative basis the S&P 500 prices are almost double cumulative earnings. Historically this has been a bad time for long-term stock market investment.

Investors need to prepare for a rougher time for US equities on a long term basis. Passive investing is not an optimal strategy for US equities as a wide range of unusual positive conditions have supported equities for several decades. It is unlikely that they will be sustained without challenges in the medium term. Unsustainable debt, inflation, and Social Security and Medicare unfunded liabilities are becoming more critical.

The last 40 years of US stocks should not be expected to repeat. In which case a much more versatile and flexible approach may be needed. This is a big subject, covered in detail in my book, and the only point I intend to make here is that current US investment allocations are not well optimized for risk adjusted returns through any environment, let alone the stagflationary environment the markets are increasingly pricing in.

Currently, investors are well placed for the last 40 years. Looking forward investors need to consider more deeply the benefits of a higher allocation to gold. Not just relative to bonds as discussed last week but also against equities.

Gold has outperformed bonds and equities over the last 3months

The S&P 500 has long swings relative to gold as shown in the chart below. Being on the right side of these swings is a game changer. It looks like the pendulum is swinging back in favor of gold. Clearly the environment is moving towards stagflation, which favors gold over equities, and technically it looks like gold has stopped underperforming against equities. A neutral allocation for gold for long term optimal risk adjusted return is likely closer to 10% to 15% rather than the current 1% we seem to find in current portfolio. Leaving aside the issue of timing I believe that many investors need to look for opportunities to raise their gold allocation.  

Bonds have been a very poor portfolio hedge in the last 30 months. Typically bonds perform very poorly in an inflationary environment, including as a hedge, as shown last week. Gold is a much better all weather hedge also for equities.

The chart below shows how well gold has performed when equities have had a significant setback.

Best Practice is a matter of your Best Interest.


Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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