Gold as a hedge

Good morning. Yesterday was fine. results from Target, a company that does not have done Just recently, he put another nail in the coffin of the “weakening American consumer” theory. There is a Target store In Jackson Hole, by the way. Maybe Jay Powell should stop by? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.

Gold hedging

How good is gold hedging? What exactly does it cover and how?

Over the past 20 years or so, gold has performed much better than the other classic diversifying hedge for an equity portfolio, bonds:

However, it should be noted that gold is not a source of constant profitability. Take, for example, the painful years 1997-2005 and 2012-2016. If stability is what you are looking for in non-stock market investments, you should look elsewhere.

But maybe I don’t need my stock hedge to give me consistent gains. What I need is for it to perform particularly well at times when stocks are performing terribly. Gold has performed well on that front recently. Below are the total returns for the S&P 500, gold, Treasuries, and inflation-indexed Treasuries in four recent market spasms:

Gold was a better hedge than bonds in the great financial crisis, in late 2018, and in the inflation and rate crash of 2022. Only in the dotcom crisis were bonds superior, and gold was still bullish at that time. Gold is a pretty good asset for risk-off times.

There is only one thing that bothers me. In 2022, much of the market’s problem was inflation, precisely what gold is most appreciated for protecting against, and yet gold fell (less than bonds, but still).

This is an important point. In response to yesterday’s comment pieceMany readers argued that gold is a special kind of currency, a store of value that is not the responsibility of an incompetent government. One commentator wrote that “the price of gold is not rising…[instead]“All fiat currencies are devaluing against gold due to the never ending wave of inflationary money printing”; another said: “You guys have [gold] to preserve their wealth while pounds and dollars are devalued year after year by M2 inflation.”

This is not entirely correct. Over decades, gold holds its value against inflation, but in any given year, or even over several years, it does not correlate at all with inflation or expected inflation. There are a couple of ways to look at this. Here we have the growth of the US M2 money supply and the rise in the price of gold:

The price of gold swings wildly above and below the growth rate of money. In 2020, gold soared as the printing presses got going, but then remained flat for several years as printing continued.

Below is a graph of year-over-year changes in the US CPI and the gold price. I have used different axis values, magnifying the smaller changes in the CPI, to make it easier to compare them to changes in the gold price:

The gold price clearly reacts to inflation, but in a very inconsistent way. Large price increases occur in times of low inflation and vice versa. In the long term, gold is a good store of value against inflation. In the short and medium term, it is usually quite bad.

Still, I’m getting excited about gold (though maybe not at $2,500!).

Gold miners

Here is a terrifying graph:

This is an ETF that includes a diversified basket of gold mining companies relative to the price of gold. Since about 2008, the underperformance of mining companies relative to the commodity has been very, very bad. Why? There seem to be two basic explanations for this, one long-term and one short-term.

There is a stereotype about the kind of people who run mining companies: they are thought to be extremely optimistic, always keen to start the next big project and not much concerned with the niceties of enriching shareholders. They end up digging a lot of huge holes in the ground and generating poor returns.

Jon Hartsel of Donald Smith & Co believes this stereotype has been largely true in recent decades. He points out that between 2011 and 2015 the five largest gold miners suffered impairment losses of $80 billion from overpaid mergers and cost-overrun projects. Investors will not buy shares in mining companies until they are sure that management teams are not up to their old ways. Investors want free cash flow, not more mines.

The North American shale oil industry used to have the same reputation for capital destruction that gold miners now have, but that has changed. So there is hope. And Hartsel points out that one company that has demonstrated disciplined capital management, Agnico Eagle, has managed to do well in relation to gold:

Hartsel writes: “Agnico Eagle…trades at a premium valuation due to its excellent track record of capital allocation and operational execution…but the industry as a whole is allocating capital more rationally as it has learned from the mistakes of previous cycles.”

According to CIBC Capital Markets’ Anita Soni, the near-term problem for miners was that operating cost inflation between 2020 and 2022 was higher than gold price inflation, leading to margin compression. Soni is hopeful that the pressure is easing and believes industry costs declined between the first and second quarters, even as the gold price rose.

This is certainly visible, for example, in From Barrick Recent results. But it will take more than a quarter or two of margin expansion for the industry to regain investor confidence.

Payroll Report Reviews

Yesterday, the Bureau of Labor Statistics revised employment numbers downward for April 2023 through March 2024, by 818,000 jobs. One thing that caught our eye was the significant downward revision in professional and business services: 358,000 jobs, or 44 percent of the total revision. We knew some consulting firms were cutting staff, but not by that much!

Stephen Brown of Capital Economics offers an explanation. The reason the BLS revises its figures each year is that its monthly results use business surveys, which do not capture changes in employment resulting from the creation of new firms and the dissolution of old ones. To compensate for this, in its monthly releases the BLS uses what it calls the “birth-death model” to produce estimates, which it can verify a year later with information on unemployment claims. According to Stephen:

Although professional services account for only 15 percent of total wage employment, the BLS assumed that professional services accounted for a disproportionate 25 percent or so of job creation among newly created firms in the year through March. That… left room for a broader downward revision in the event that the birth-death model was overestimating job gains.

The Bureau of Labor Statistics had reason to believe that professional services would outperform: Between 2012 and 2022, the number of people employed in professional services increased by 33 percent, behind only construction and transportation, driven in part by the founding of new businesses. But the model was clearly too optimistic.

Have high interest rates somehow prevented white-collar professionals from starting new businesses? Or is something else going on?

(Reiterate)

A good read

Convention clothes.