“O Gold! I still prefer thee unto paper,
which makes bank credit like a bark of vapour.” – Lord Byron
What’s Going On With Gold Prices?
When the stock market crashes, gold prices skyrocket. That, at least, is the common wisdom. And there is good reason to believe it. Fear of losses in “paper” assets sends many investors running towards tangible assets – precious metals, art, and real estate. Anything of value that you can touch and hold.
But when the Dow began to tank early this month, the value of gold went down. Within a few days (March 16), the price for an ounce of gold bullion had dropped by $160, or 9%, bringing it down a total of 11% over 30 days.
(The price of silver went down even more – by 34% over the same 30 days.)
Several readers wrote to ask: What does that mean?
As I try to say each time I speak about investing, I am not an analyst. And I don’t pretend to have any expertise in understanding the financial markets, other than the experience I’ve had in running and consulting with businesses. I’ve made my investment decisions based on the logic of business, combined with the advice of investment analysts and specialists that I know and trust.
In this case, I turned first to Tom Dyson, my former partner at Legacy Publishing, who helped design my stock portfolio and whose current work centers on the ratio of gold to stock values.
Tom said he was initially as baffled as I was with the drop in gold prices. Especially so since he had spoken to several gold and bullion insiders. In a recent blog post, he highlighted some of those conversations:
From Kenneth Lewis, the CEO of Apmex, one of the major American gold bullion dealers:
“We are having record-breaking sales and demand across all channels; Apmex, Wholesale, OneGold. Apmex/OneGold Sales and Customer Service both handled more than 1,400 calls Friday, as compared to a typical daily volume of 390, and Monday’s calls are even exceeding Friday’s volumes.”
The demand for silver, Lewis said, is even higher:
“We have not seen volumes like this in more than 10 years. You have to go back to 2008. These are crazy times in our world and I believe we will be in tight supply for several months.”
Tom checked with two or three other dealers and got the same report.
Tom calls it an “upside-down pyramid.” At the bottom is physical gold. At the top are futures, gold options, and other gold derivatives.
The market for physical bullion is “tiny” compared to the demand for all these stock plays, which Tom calls “notional” gold. The volume is a thousand times larger. “If this is true,” Tom reasoned, “then it’s the supply and demand in the notional gold market that sets the gold price… not supply and demand in the physical gold market.”
This could explain the anomaly, Tom said. But he expected bullion prices to go up eventually.
That was then. This is now.
He was right. In the last week, gold prices spiked by 10%. In a single day, they rose by 5.6%, an historical record.
As Tom pointed out, this was caused primarily by a lack of liquidity in the bullion market. There was more demand for it than supply. The coronavirus caused some of that – bullion manufacturers shut down. But there are myriad possible reasons.
Goldman Sachs attributes the run-up to “inflationary concerns”:
“Combined with the fiscal nature of the current policy response to Covid-19, we believe physical inflationary concerns with the dollar starting near an all-time high will for once dominate financial asset inflation that was a feature of the past decade.”
Another analyst, Anita Soni, had this to say:
“Near zero interest rates, market uncertainty, and ongoing liquidity injections provides a bullish setup for gold and silver…. This has created an excellent opportunity to buy the dip across the sector.”
Brien Lundin, editor of Gold Newsletter, had a different perspective:
Gold’s big move on Tuesday “isn’t due to worries over a greater economic fallout from the coronavirus, but rather in anticipation of the flood of central bank stimulus that is all but guaranteed by the effects to date.”
When the price of gold bullion moves up, the price of equities based on gold usually moves up even faster. As I’m writing this, shares of Royal Gold (NASDAQ-RGLD) have risen almost 14%, while shares of Yamana Gold (NYSE-AUY) are up nearly 17%.
As you know if you’ve read any of what I’ve written on gold over the last 20 years, I’m not worried.
As I said in an essay published four years ago, I did not buy gold to double or triple my money when the stock market crashes. I bought it to insure myself against the possibility that the USA economy might one day collapse.
If things really went to hell in a hand basket, I explained (and all my brokers and bankers closed shop), I wanted to have a stash of gold coins – something of value to barter with, something tradable that I could use to get my family to a safe place and then support them.
I said that when I bought gold in 2004, I thought the market crashing back then was very remote. But “since the price of gold at the time was in the mid $400s, I figured the downside was very limited. In other words, I believed that the premium for insuring myself against a class-4 financial hurricane was quite cheap.”
Most analysts that write about gold don’t think about it like that. They usually describe it as a “chaos hedge.”
Now you may think that the difference between “chaos hedge” and “chaos insurance” is a matter of semantics. It’s not.
“When you buy a hedge,” I wrote, “you are making an investment to counterbalance another…. Corn farmers, for example, might buy futures contracts that will pay them handsomely if the price of corn will go down. The money they make from the futures contract offsets the money they would be losing on selling all their corn at a discount.”
In other words, a hedge is an investment meant to maintain your net investible worth. So if stocks tank due to some major political, economic, or (in the case of the coronavirus pandemic) social event, the gains you make in gold would offset those losses.
“In a financial collapse accompanied by hyperinflation,” I wrote, “the price of gold could easily quintuple. If 20% of your assets were in gold, you could maintain the same investible net worth even if the rest of your portfolio (in stocks, say) went down by 80%. I’m not attracted to that idea. And I’ll tell you why. If we really did have a financial collapse of Armageddon proportions, I would expect the entire financial world to fall apart, including all the major banks and brokerage houses.”
I then pointed out that if we have a collapse of that magnitude, it is quite possible that gold stocks (and derivatives and so on) could go down too. “I can’t reasonably imagine a situation where the rest of the stock market dives by 80% and gold stocks soar by the same amount,” I wrote. “In that sort of situation, I’m thinking every financial institution will close their doors – and even digital money will no longer work.”
I concluded that buying gold stocks as a chaos hedge was not for me. I wasn’t willing to have 20% of my net investible worth in assets that produced no income.
On the other hand, I liked the idea of buying gold coins as insurance against chaos. In the highly improbable event that the ATMs really do stop working, I said, I wanted quick and easy access to gold coins that I could trade for food and shelter and transportation and protection.
As for the price of gold bullion, I said, “I have no idea whether the price of gold [in such a scenario] will rise or fall or remain the same. I only know that if it drops all the way down to $450, I will still have the coverage I need.”
So I never liked buying gold stocks as a chaos hedge because I believed that if we had such a level of chaos there would be a good chance the entire stock market would be down and dysfunctional. And I didn’t like the idea of buying gold coins as a hedge because, “although I think it is probable that the price of bullion might increase in chaos, I can’t be sure.”
And that’s why the premium I paid for my gold coins was not 20% of my net investible wealth, but 2%. That was then, at $450 an ounce, enough to take care of my family for five years. Today, with gold trading at about $1,500, my family should be good until well after I’m no longer here.
But again, the insurance I have against financial disaster is not gold but my other income-producing assets, and especially the tangible ones like rental real estate. That income will certainly decrease while this current crisis continues, but it will not disappear.
If you have no gold but are thinking of buying some, I wouldn’t trade in Legacy stocks to buy it. Gold could double. But Legacy stocks will definitely come back.