Happy 50th Anniversary, Gold

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Posted: Sep 07, 2021 9:22 AM
Happy 50th Anniversary, Gold

Source: AP Photo

Friday the 13th of August 1971 was a very important date in U.S. history. It was the date that set the table for the beginning of the end of the USD's world reserve currency status. And, greatly expedited the road to perdition for the dollar's purchasing power.

That means just last month was the 50-year anniversary of President Nixon's absolute termination of the dollar's ability to be redeemed for gold. Therefore, I thought it would be a good idea to review gold's performance since that time against some popular investments—especially since the MSFM took this same opportunity to impugn this most precious of metals—as they are always prone to do. And, to also once again explain what really drives the gold market.

Here's a good example of what the media is saying about gold right now: "Nobody wants your rocks, right? I mean, the gold bugs have come up with every story under the sun as to why gold should go up, and it doesn't." That's according to one J.C. Parets, Allstarcharts.com founder and chief strategist, in an interview with Yahoo Finance. He continued: "In fact, over the last year, you'd be hard-pressed to find a worse investment over the last year [than] gold." Joining Yahoo in the poo-poo parade for gold, Bloomberg and the Wall Street Journal ran comparisons between gold and the S&P 500 since 1971--both before and after dividends are factored in. According to the reports, gold beat the nominal return of the benchmark Index but trailed once dividends are factored into the picture. Their conclusions: gold is not a great short-term hedge against inflation, and stocks offer far better protection from a rising Consumer Price Index.

Here's my take: I've said many times before that while I might be a gold bug at heart, there are times when gold can also rip your heart right out. However, the truth is that gold is great hedge against inflation over the long run; but it does even better if you actively manage your allocation weighting.

When looked at with a less biased eye than Wall Street's, there are some salient conclusions that can be drawn from the performance of gold since the Fed broke the gold window in 1971. Gold has not only kept pace with the return on the S&P 500 (before inclusive of reinvested dividends) but has actually beaten intermediate-term bonds over the past five decades. So no, it hasn't become the worthless rock that Wall Street and the Bitcoin crowd would like you to believe. Also, there are intervals and cycles when gold vastly outperforms and underperforms the market. Hence, while it is true that gold can be a very profitable investment, it is also true you should actively manage your allocation to PM to hopefully avoid the huge drawdowns that take place.

Some more facts you should know: The July reading on CPI had it rising at 5.4% and the PPI soaring 7.8% Y/Y. That's the highest U.S. consumer price inflation in nearly 40 years and the highest producer prices on record. However, the dollar price of gold is actually down over 6% this year and down about 10% over the past 12 months. And the miners, as represented by GDX, have shed nearly 14% this year and are down 25% y/y. So, why is this most-beloved inflation hedge performing so badly of late? That is because the price of gold depends mostly on the direction of real interest rates. Real rates had been rising in the first two quarters of this year, forcing gold lower. However, the direction of real interest rates has begun to fall during Q3. I believe this process should intensify next year. Falling nominal and real rates next year should provide the gold market with a strong rebound, especially after the tapering of QE begins.

But what all this proves is that Wall Street is not only biased against gold but hopelessly ignorant as to the real function of the precious metal. It is crucial to understand that gold isn't really an investment, like stocks or bonds. It doesn't grow its earnings, or pay dividends, or even offer any interest like fixed income. Gold mining stocks are investments, but the metal itself is not. Gold is a competing currency that must be measured against the return on cash. It offers a viable replacement for dollars that exist in a completely liquid savings or checking account or short-term Treasuries. In other words, the performance of gold is most accurately measured when compared with the returns on holding cash or cash equivalents. Gold should not be compared with stocks or long-duration bonds. However, gold can still very favorably compete with those investments, especially during times of stagflation.

When nominal interest rates are being capped by central bank money printing, the rate of inflation tends to rise, and economic growth tends to falter. That's called stagflation (a combination of slowing economic growth and rising inflation), which is the best environment for gold.

Even though gold is not technically an investment (investments are meant to provide a real, after-tax return on your money), it is the best form of money humans have ever found. And, despite gold being the best place to park your wealth to maintain its purchasing power, it still has a 50-year history of being very competitive with bonds and stocks—even though that comparison isn't a fair one.

Of course, when compared with the Fed's crappy currency, gold shines brighter than a supernova. For proof of this fact, it took just 35 dollars to buy an ounce of gold in 1971; but today, it takes about $1,800. Sadly, since 1913 the dollar has lost 96% of its purchasing power. Hence, you must evaluate gold in a fair and honest fashion. When doing that, gold proves its value over many millennia. No fiat currency can do that. In fact, all eventually have gone to zero.

Testing a theory in an objective and unbiased fashion is the only way to arrive at the truth. Gold isn't an investment but still beats U.S. government bonds and the S&P 500 prior to dividends. And, it trounces the performance of all fiat currencies. Indeed, gold is a great store of value that has proven effective to maintain your standard of living for thousands of years. Knowing how to trade gold can make it even more precious.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”