Last week, veteran investor and Mobius Capital Partners Founder Mark Mobius advised investors to have at least 10 percent of their portfolio in physical gold to protect their purchasing power. He expects a significant devaluation in the world’s major currencies next year following the unprecedented fiscal and monetary stimulus rolled out by major economies to fight the COVID19 pandemic.
Mobius' contra call on the yellow metal came after Federal Reserve Chairman Jerome Powell hinted at a slower than expected withdrawal from easy monetary policy in his latest speech on August 27. It led to an immediate rally in risk assets globally and fuelled fresh concerns about global inflation and currency devaluation.
The simultaneous devaluation in the world’s major currencies such as the US Dollar, Euro, Japanese Yen and British Pound Sterling can only happen in two ways – a rise in consumer inflation that reduces the purchasing power of holders of these currencies or through a rise in gold prices that devalues fiat currencies relative to gold prices. Consumer inflation has been on the rise across the globe for nearly a year now but gold has been a laggard.
So should you heed his advice and start accumulating gold at current levels? A cursory look at the historical data on gold and equity prices give a lot of credence to Mobius’ advice.
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In the last 12-months, the Dow Jones Industrial Average is up nearly 24 percent while gold prices (in US dollar) in the spot market is down by nearly 8 percent. This has created a big performance gap between these two asset classes.
Money supply continues to grow
In the meanwhile, the US Federal Reserve -- which sets the tone for the global monetary policy -- continues to pump liquidity in the financial markets. The Federal Reserve Bank monetary base, which determines the money supply in the US economy and by corollary globally, is up 27.5 percent in the last year from US$ 4.8 trillion at the end of August last year to around US$6.1 trillion currently.
Monetary base or high powered money includes all currency in circulation, bank deposits and bank reserves deposited at the Federal Reserve. In short, the monetary base is the sum of all monetary assets that can be used to buy any goods, services or financial assets in the economy.
In the same period, the total balance sheet of the US Federal Reserve expanded by nearly 18 percent from US$ 7 trillion to US$ 8.33 trillion now. The result has been an abundance of liquidity in the global financial market. So far a large part of this liquidity has gone into equity markets, real estate, industrial commodities and alternative assets such as bitcoins.
Liquidity lifts all assets
But it’s a matter of time before some of the liquidity starts flowing in the gold market as well.
In other words, when one does better the other lags behind. For example, the spot gold prices in the US dollar is up 228 percent since January 2006 against a 22 percent rise in Dow Jones Industrial Average during the period. (Chart-A)
So while both asset classes have given similar returns over the long term, their short-term performance varies a lot.
For example, gold outperformed Dow by a big margin between 2007 and 2011 but was a big laggard for the next seven years even as stock prices across the world made new highs. Gold again began to rally from September 2018 and out-performed Dow Jones for the next two years by a big margin.
And in the last one year, equity has been one of the best asset classes while gold has given negative returns after touching a new lifetime high.
Dow-Gold Price Ratio
This cycle suggests that it’s a matter of time before gold once again comes on top and leads the next cycle of the rally in asset prices as long as central banks continue monetary expansion.
This valuation measure is captured by the Dow to gold price multiple which is the ratio of Dow Jones Industrial Average value divided by the spot gold prices.
At its current level of around 35,400 a unit of the Dow Jones index is nearly 20 times more valuable than an ounce of gold in the US spot market. This is nearly 35 per cent higher than the ratio of the 15-year median value of 14.3X. Historically this ratio has oscillated around this median value -- rising when it falls too low and correcting when it gets too high. The reversion to means happens through the relative out-performance and underperformance in gold prices relative to equity. (Chart B)
Don't get discouraged if it continues to underperform for some months more. In 2007, the gold rally had started from Dow to gold ratio of 21X while the 2018 rally had started from a ratio of 22X. So start buying and don't wait to catch the bottom.
(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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