Gold is Money, Everything Else is Credit.

Gold’s traditional role in portfolios is as a haven in times of stress or perceived high risk on a shorter-term basis and longer term as an insurance policy against a decline in the value of the dollar. Gold’s recent run is interesting because it has come in the face of some factors that would normally cause the price of gold to fall.

Short term gold price moves are often correlated with movements in the dollar, which, in turn, is often driven by interest rates. High rates in the U.S., relative to other developed countries, attracts investors to the dollar investments and pushes the relative value of the dollar higher versus other currencies. Gold, of course, pays no interest, so higher rates tend to make gold less attractive on a relative basis.

What is a bit odd about gold’s strong performance since the beginning of 2023 is that it has come in the face of rising/high U.S. interest rates and the recent surge has come as the Fed has delayed pending rate cuts (see chart below).

On the surface gold appears easy to analyze, watch interest rates, watch the dollar and everything should fall into place. If rates fall, the dollar should decline and the price of gold should tend to rise. But there is far more to gold than interest rates. Geopolitical risks can tend to push gold prices higher as well, and this has certainly been the case since the Hamas attack last October.

Making the picture a bit more confusing is the fact that the recent gold price rise has come in the face of substantial outflows from gold ETFs (see chart below). If money is exiting gold ETFs, yet the gold price is rising, it has to be because somebody else is buying, and that would be central banks.

Although fiat currencies, like the dollar and Euro, are not backed by gold, the U.S. and EU central banks, as well as most other central banks, use gold as a critical monetary reserve and use it to stabilize the value of their currency. If China and Russia desire to de-link from the dollar hegemony, swapping dollar reserves, which are subject to sanctions, for gold reserves, which are not subject to sanctions, will be an important piece of the puzzle for them. That shows up in the data, as central banks added some 39 tons to global gold reserves in January and that marks the 8^th month in a row of net additions to gold reserves by global central banks.

What Do Central Banks Know That We Don’t Know?

Maybe nothing. Certainly central banks react much as investors do when geopolitical risks rise, and this could be the explanation, but the U.S. has been on an unprecedented spending spree since COVID which is resurrecting concerns about fiscal deficits and the long term stability of the dollar. The deficit spiked during COVID as the result of both massive government spending and lower tax income, but since then the spending has accelerated once again. (Chart below.)

One of the reasons that we always own gold in our portfolios is that there is a limit to how much anyone, even the U.S.A., can borrow. The problem is that you don’t really know where that limit is until you hit it. As Hemingway says in The Sun Also Rises, you go bankrupt two ways, gradually, then suddenly. One potential reason for the advance of gold, and Bitcoin, for that matter, is this concern over the financial stability of the U.S. Certainly the gold market is not yet panicked, but with both geopolitical issues and U.S. budget deficits escalating, this appears to be a time for gold to shine.

Short Take

It is now more than a year since the S&P 500 has had a 2% drop in a day and this is the longest streak since the beginning of 2018.

Have a great week!

What We’re Reading

What Is the Federal Reserve and How Does It Work?

The inflation battle is not done, says Piper Sandler’s Craig Johnson (4 Min. Video)

College is still worth it, research finds — although these majors have the lowest rate of return

Likelihood of total TikTok ban (5 Min. Video)

Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

General News

By: thinkhouse