In 2017, gold prices rose a solid 11.63%. Another impressive year for boring old bullion. This at a time when the popular media can’t stop talking about racy, obscure “cryptocurrencies.”
In fact, since the world’s central banks began falling off the wagon and adopting radical monetary policies in 2000, gold has performed better than stocks, bonds and many other commodities.
But gold is still not on the radar of many investors.
In his recently published year-end investor letter, Senior Portfolio Manager John Hathaway of Tocqueville Asset Management L.P. shows why overlooking gold could be a critical mistake for retirement investors in 2018.
JOHN HATHAWAY’S 8 REASONS FOR INVESTING IN GOLD
The famed investor is bullish on gold in both the short and long term. Here is why:
1. Extreme Valuations in Financial Markets: Hathaway thinks renewed interest in gold will soon be triggered by an inevitable stock crash. Hathaway is not a market timer, but he recommends deploying strategies that have a proven track record of mitigating risk in any market. According to Hathaway, investors should consider physical gold before any market correction happens.
2. Deteriorating U.S. Fiscal Position: The federal deficit is growing rapidly late in a mature business cycle. The fiscal deficit for 2017 was roughly $20 trillion, only nine years after it topped $10 trillion. Under the new tax code, the deficit is expected to rise by several hundred billion dollars. Between the tax cuts and an assumed 2% rise in interest rates on outstanding debt, Hathaway expects an $1 trillion increase in U.S. deficits in the next two years. According to Hathaway, this will cause government borrowing to “crowd out” private needs.
3. Rising Inflation: Hathaway sees inflation coming back in 2018 with the budget-busting Tax Cut and Jobs Act expanding deficits even if the economy is strong. He cites little known indicators like the ECEC (Employer Costs for Employee Compensation) that rose 1.3% in the third quarter of 2017. How can inflation remain below 2% while wages increased from 1.3% to 4.4%? If inflation emerges and the Fed acts too late, he thinks a weaker U.S. dollar and rising gold prices could be the end result.
4. Precarious Structure of Financial Markets: Passive investing and machine driven trading are, in Hathaway’s view, culprits in stratospheric valuations of stocks. According to Hathaway, risk-mitigating strategies such as risk parity and volatility targeting are reminiscent of portfolio insurance leading up the market crash of 1987. He thinks the asset-management industry has undergone a qualitative transformation that almost guarantees large-scale capital flight from stocks in the event of a sudden or prolonged downturn.
5. Bullish Supply and Demand Outlook for Physical Gold: Physical gold is in short supply while demand for physical bullion is on a steady growth path. Hathaway believes we will continue to see migration of physical gold to China, India and other Asian nations.
7. Expected Further Weakening of U.S. Dollar: Hathaway expects inflation and the fiscal deficit to rise and the U.S. dollar to weaken further. While a weak dollar is bad for our country, it is also good for gold.
8. Gold as an Ideal Portfolio Diversifier and Risk Dampener: Hathaway believes that an allocation to physical gold could reduce downside exposure during periods of market stress and deliver some outperformance over a longer period of time. He says a small portfolio allocation to physical gold since 1987 would have resulted in outperformance versus a 60% stocks and 40% U.S. Treasuries allocation. In his view, gold exposure can be a simple but historically effective way to help protect capital over long periods of time when other markets or currencies fail.
Whether you buy into every piece of his argument or not, you might well find even just one factor above as reason to consider… just how diversified you are in your own portfolio?
Has your asset allocation drifted off target recently because of recent outperformance by certain markets?
Time to consider how much of your portfolio is allocated to safe haven assets like gold. In fact, this is a question worth asking quarterly, or at least once per year.
HOLMES IS BULLISH ON GOLD TOO
Like John Hathaway, Frank Holmes is bullish on gold as well in the long term. Holmes recommends owning gold as an appealing diversifier in the event of a correction in the capital markets.
According to Holmes, gold prices could be a bargain. He believes too much money has been invested in stocks and that growing debt and deficits could result in higher gold prices down the road.
Holmes also thinks that history has not been kind to investors when the Fed tightens and these rate hike cycles are ominous warning signs of a pending recession.
NEW TAX LAW: WILL IT EXPLODE THE DEFICIT?
While the new U.S. tax law is still under examination to determine winners and losers, there is ample reason to worry that our new tax structure could rapidly inflate the nation’s budget deficit.
Hathaway and other investment professionals warn that a deterioration in the nation’s fiscal standing is a recipe for higher silver and gold prices. From 1984 through 2012, gold rose as the federal debt expanded relative to GDP. Stocks appear to be overvalued by any reasonable measure, and inflationary signals are cropping up.
Against this backdrop of higher capital market risks, geopolitical tensions are escalating. There is no shortage of social, economic and political hot spots globally that could ignite the next flight to safety.
Hathaway rightly asserts that physical gold could be the simplest way to add safe haven diversification to your IRA or 401k.
We encourage you to consider opening a Gold IRA and take steps to diversify your exposure to risk. Sadly, history always seems to repeat itself.