Gold and negative yield debt
Summary:
- Main relationship: gold grows when other inflation-adjusted assets begin to yield small returns
- The more bonds yield negative returns, the more demand for gold
- The value of gold (the number of which almost does not grow) depends on the amount of money printed by the world's central banks.
Introduction:
Recently the gold bounced off the level of $ 1550 and is moving in a downward range around the level of $ 1500. A year ago the price of gold was in a downward trend, but now for 2019 gold added 15% to the price - very good for a protective asset.
Global trade tension, a slowdown of the world economy, fear of future crisis, risk-off - all this influenced gold and many words have been said about it.
But what moves gold fundamentally? What are the main forces in this trend? Let's see what the basis of this growth is and what instruments gold correlates with.
Gold and inflation
Since a deposit in dollars generates income and gold is not in itself, the price of gold, in the long run, depends on inflation. When the difference (us10y) - (inflation) falls, gold becomes more expensive because gold itself is a commodity, its supply in the world is limited and it becomes more expensive following price increases.
For example, it can be seen that most of the time the gold chart correlates with the yield of 10-year U.S. government bonds adjusted for inflation:
Source: Sprott.com
The culprit of the rise in price - assets with negative returns
Perhaps it will be a surprise for you, but gold has been rising in price for about 4 years - since 2015. Since then, real yields have been rising and falling, but there is another important factor - bonds with negative yields.
Have you heard of such bonds in Japan and Europe? - Central banks in these regions have made interest rates negative to encourage banks not to keep money in the market, but to lend to the real economy (but, alas, it did not help much).
As a result, now almost $17 trillion of bonds give a negative yield before the inflation correction. Comparison of this volume of bonds with the price of gold clarifies the picture: it is better to get a zero yield in gold (and income from the growth of the dollar and the euro and yen) than a negative one:
Source: MeridianMacro (2015-9/5/19)
How can a bond have a negative yield?
Because the economy is slowing down (middle business cycle) and the recent inversion of the U.S. debt curve (a big hint at the crisis in the next year and a half), most investors are investing in bonds, therefore pushing their yields down.
Yields on bonds turn negative when an investor buys them in an amount exceeding their nominal value.
Large investors, such as pension funds and large fund funds, are willing to pay premiums and lose 100% of their money on bonds with negative yields. They have few, if any, safe places to store their clients' funds that provide the reliability and liquidity fully provided by the government and high-quality corporate bonds.
Source: Bloomberg.com
When real and nominal returns become negative, there are very few alternatives.
Gold makes sense as an alternative, given its high inverse correlation with lower returns (both real and negative nominal returns), its role as a historical repository of value in negative returns, and its lower overall volatility and lower correlation with other asset classes
In the past credit crisis, there were virtually no negative yield bonds.
This will be a significant and new driver of gold in this cycle.
Will the trend continue?
Taking into account that all the Central Bank of the world continue to soften, Trump wants to weaken the dollar, and the world is full of risks - Brexit, trade wars and many other things (the end of the economic growth cycle after all), I have no doubt in the continuation of the trend.
Also, the value of gold (the number of which almost does not grow) depends on the amount of money printed by the world's central banks.
The Bank of Japan, the Central Bank of the Eurozone, until recently the Federal Reserve Board, and the Central Bank of China are all struggling with a slowdown in the economy and to make loans more affordable. This is the reason why the value of gold is growing.
How to benefit with it
There are two fundamentally different ways:
- buy gold directly through an ETF or gold futures contract and grow as it is sold. Through a futures contract, you can take on a "shoulder" to earn more
- There is also another way to buy shares of gold mining companies or ETFs for a basket of such companies.
Historically, gold miners have been growing 2x to 3x faster than gold (though with a lag: the market is convinced that new gold prices are stable, companies are increasing their profits and their shares are growing)
Why is that? - It's simple: with a price of $1400/oz, many companies have costs of about $700-1000 per ounce, so a 10% (+$140) rise in gold prices gives a 20%-30% increase in profits
«Я считал, что впереди выбор между разгоном инфляции и дефляционной депрессией, а потому держал активы в золоте (чтобы застраховаться от ускорения инфляции) и в облигациях (на случай дефляционной депрессии). До этого момента золото и облигации двигались разнонаправленно в зависимости от того, росли или снижались инфляционные ожидания. Эти позиции казались более безопасными, чем альтернатива в виде наличных, которые обесценились бы в условиях инфляции, или акций, курсовая стоимость которых упала бы во время депрессии.»
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