Gold’s Utility as Portfolio Diversifier
Jordan Roy-Byrne: Hello again, everyone. Welcome back to the Atlas Investor podcast with Tiho Brkan, thank you so much for tuning in today. We really appreciate it. Tiho, my friend, I want to ask how you're doing today and what will we be covering in this episode number 21?
Tiho Brkan: Jordan, I'm doing very well, thank you for asking. We'll be looking at the precious metal sector, something that you are an expert in. So we're gonna have a little bit of a twist today, as opposed to the way we normally run the podcast where you interview me. I'll be doing a little bit of an interviewing job myself and trying to get some nuggets of wisdom from you as to where the precious metals market might be headed in the next couple of months and what we should do now that gold and the precious metal sector has sold off.
I'm really looking forward to taking the other side of the mic, here. Let's see how I do, I'm a little bit nervous.
Jordan Roy-Byrne: Okay Tiho, one of our favorite subjects, one of my favorite subjects especially, gold: what it's doing, where it's going. What would you like to discuss here as we start?
Tiho Brkan: Okay so the first chart that I have for you, for the listeners at home, that are on YouTube and those that are reading on our website, is the long-term chart of gold dating back to 1970. This is around the time that President Nixon took off the gold standard and floated gold on the exchange, as well as the US dollar which started trading against other currencies.
Tiho Brkan: It's an interesting chart. It shows the return, the volatility, all the characteristics basically of gold since 1970. Before that, it actually was pegged to the dollar so it wasn't as tradable as it has been in recent decades.
Why don't you start off by telling us what you have noticed in characteristics of gold over the many decades, why you favor gold as an investment class, and what its positive attributes are that one should consider when they are allocating capital to it as an investment manager.
Jordan Roy-Byrne: Okay that's such a great question there. There're a couple questions in there, so I'll try and unpack that as quickly as I can.
As far as gold over the decades, something I've noticed which is very interesting to me and I think this is pertinent right now is its negative correlation with US equities. There's only been one time gold has had a bull market, I mean a real bull market, a real cyclical bull market, without the S&P500 having a bear market around the same time. That could either be during or before. And that was from 1985 through 1987, where we had this massive decline in the US dollar thanks to the Plaza Accords and the dollar devaluation. But when you look at the size of that decline, which was about 50% top to bottom, but less so from '85 to '87, you will notice something.
Even with that kind of decline, you would've expected a stronger move in gold and precious metals. If we remove that from the equation, you basically have the points where gold has been the strongest were in the 1970's and during the last decade. And as we know those were difficult decades for US equities. From a portfolio standpoint, for high net worth investors, and those who want to allocate broadly and not just do the typical 60/40 portfolio, gold works best when the US equity market is struggling.
Fundamentally speaking gold works best when real interest rates are declining, and when they're negative. When real interest rates are strongly positive and where they're rising, that means the fundamentals for keeping your money in the bank or keeping your money in a CD, or in a bond, are improving and therefore they're worsening for gold.
With respect to gold, you really need one of two things to happen. You really need inflation to rise or accelerate; if that's not happening you really the fed to be cutting rates. Now that doesn't answer everything, but that can at least help us understand when gold performs best and when it helps your portfolio. Where we are at present, Tiho, I would say that, and I've been saying this for the last couple years: I don't think we're going to see gold in a bull market until we see the economy go into a recession and we see the S&P fall into a bear market. That is when gold can actually work best, as a portfolio diversifier.
Given the history that I talked about, given where it is here and now, obviously in the last couple years it had a big rebound in 2016 in the first half, after that decline, that downtrend from 2011 to 2015. But since that happened, it went sideways for about 18 months. It tried to break out earlier this year but it failed. The recognition of that failure is what led to the strong sell-off that we've endured over the last couple months.
Not coincidentally, I would say, the US equity market during this period has been strong and also the US dollar strength factors in. The US dollar has had a really strong move since, I think, February of this year. I know we're going get to sentiment, but in the big picture, gold has failed to break out so the primary downtrend we have to say, has reasserted itself.
Tiho Brkan: Very, very interesting. In summary, you would say that gold is a very good diversifier, it tends to protect investor's portfolios as an insurance policy. In particular during times when other asset classes such as equities, income-producing asset classes such as equities or maybe even bonds, both of which failed to protect investors in the '70's; gold and natural resources, farming, and agricultural assets did terrifically. Very, very interesting.
I tend to hold gold, both in my trading account of the portfolios for my clients, as well as generally speaking in the physical form as well as in the futures or ETF form just for the sake of diversification.
One of the things I would like to talk to you about in particular is this move from April. I remember talking to my clients and they will remember this, in late March and early April we started allocating some of our portfolio back from cash into S&P500 after missing on that correction in February as well as in March. The two swooped down which produced about a ten percent drawdown and increased volatility substantially from 2017.
And what I've noticed is that it was around this time that I was buying when the news was very bad about the trade war, and at the same time, one of the reasons that I bought was because gold was telling me that it was smart to buy equities. Gold refused to make a higher high just as the news was favorable for gold to break out and just when it should've been protecting investors during a trade war, and clearly the market thought that the trade war will probably find some kind of a solution couple of months down the track.
I'm not sure if that's true or not, I'm just trying to read the market's message. Do you think there's any other reason why you think gold broke down away from just the correlations with the dollar and so forth?
Basically, the question is why do you think that gold is reasserting its downtrend?
Jordan Roy-Byrne: Well I think obviously there could be many reasons for these moves, but I think you nailed it with the trade war.
Maybe the trade war will be inflationary but we have no idea if it's going to be inflationary in the next quarter or two. Who knows, it might not be inflationary for another two or three years, and that's why you have to respect what the market does.
Looking at gold's fundamentals the last 18 to 24 months have been very interesting to me because in 2016 if you look at real interest rates, we had a sharp decline for most of the year. That's the fundamental explanation for why gold did so well in 2016. However, what happened in 2017 was very interesting because real interest rates started increasing again in 2017 and they've remained steady this year and in some calculations even rising this year. So the fundamentals for gold over the last 18 months have, as far as real interest rates have actually been getting worse.
But what happened? We had this huge decline in the dollar in 2017 and that really kept gold from breaking down. If we look at gold denominated against other currencies or denominated against stocks over the last 18 months, there really wasn't much of an uptrend there. It was mostly a sideways move and kind of weak. That happened despite this huge decline in the dollar.
Another thing, compared to gold's peak in August of 2016, so about two years ago from where we're speaking now, from that point the dollar penetrated that low twice in 2017. Yet gold, despite that happening was unable to make a new high both those times. There were a lot of bearish things for gold under the surface in 2017 and so once the dollar started rallying after February of this year, Gold lost that support both literally and figuratively.
And you made a great point. The stock market bottomed during this trade war news, and when the market rebounded in the spring that to me was very negative for Gold. I figured, if the market is rebounding and it's on a solid footing here, gold is not going to break out. And we saw what happened, as you noted, gold was unable to break out, this market bottomed, and the dollar's rebound continued.
And then with the decline in gold, or as that decline was happening the market had a realization that the primary downtrend was reasserting itself.
Tiho Brkan: That was very interesting, Jordan, thank you for that.
Even though we discussed how gold has broken down, and there was a variety of clues as to why it might break down, that doesn't mean at least in my opinion, that all downtrends are a straight line. What I would like to ask you is, and some of the charts that I've prepared for you as well, is how do you feel about the current sentiment, the current positioning, the actual surveys that are reflecting trader's opinions and moods, and the current breadth readings that are happening in the overall precious metals market.
So why don't we start with the hedge fund positioning? Depending on which way you look at the dollar, some people would say it's quite extreme. What do you think?
Jordan Roy-Byrne: Yeah, it really is extreme. If we look at the hedge fund positioning, hedge funds are massively short. They're the shortest they've been. I believe the data goes back to the mid-2000's. Our listeners or viewers can see how the hedge funds have never been this bearishly positioned in gold.
Look, some of those hedge funds, they've probably made some money, so at some point, they're going to have to cover and that's what we've been seeing in recent days where gold's been able to rally from I think 1167 up above 1200. It remains to be seen how far this rally might go and how much more short covering there is to be.
That's just one of the many extremes. You also noted we have another chart here, of the sentiment. This is the optix index from sentimenttrader.com.
Tiho Brkan: I'm so sorry to interrupt you, but I'd just like to say that the guys who do this website are really, really good so if you haven't signed up, please do. I don't get any benefit and neither does Jordan when we say this, but I highly recommend their tools and it makes you a better trader. Jordan, so sorry, but please continue.
Jordan Roy-Byrne: Sure, yeah, no worries.
So this chart from sentimenttrader.com is the gold optix and we can see that over the last 19 years this is one of the five most extreme lows. There are a couple other ones that stand out, you have one at the end of 1999 and then early 2001, so those two are right when gold made that major double bottom. Then you have another one, which was a few months before the bottom at the end of 2015 and then you have one in 2013 which was gold's low after it had that crash in the middle of 2013.
These are points where the market has been extremely oversold, and the question is, is this going to be similar like we saw in '99, 2001, or at the end of 2015, or is it more similar to 2013? Of course, it remains to be seen, and as you always say Tiho, "the market will tell us which way it's going." If I have an opinion, my opinion is this is probably going to be more like 2013. I don't think we've seen the absolute low for this move for gold.
Now moving on, another indicator that hit a major extreme, and this is one of your favorites, is looking at 52-week lows and the percentage of gold mining stocks that hit a new 52-week low.
This hit minus 70% and this is something that my subscribers are aware of because I use this and you turned me on to this in the last couple of years. It's been very helpful.
I believe the -70% reading was a week or so before the day we are recording. Going back over the last five to ten years or so, this is one of the most extreme readings we've ever seen. There was one in 2013 and one in 2014 where that indicator surpassed 80% to the downside. But for those of you looking at this, you can see that at worst after you hit this there is a rebound and we are starting to see a rebound in gold mining stocks.
Moving on, Tiho, one more thing. You have the bullish percentage index for gold mining stocks and this indicator is not quite as oversold as the other indicators but it did tick below 20%. I think it's the second or third, lowest reading over the last several years. So not quite as extreme as the others, but certainly extreme enough to signal some kind of interim low.
With that said, Tiho, I want to hear your comments on some of these indicators. I would ask you, how much of a rally do you think we can see here? Is this something that can last more than a couple months, or is it only going to be something that lasts a couple weeks? Do you have any thoughts on that?
Tiho Brkan: First of all Jordan, great summary. I have to say, you did a really good job there and very interesting indicators that we're discussing here.
To answer your question, I'd say gold, despite the fact that we're having a rebound even now over the last week and a half or so, gold is still down five months in a row. If I was a gambling man, and I'm not, I would probably say that gold would have at least a one to two months rebound. We have good seasonality coming up, September, October, November, December, tend to be at times good for gold, and at other times not so good for gold.
Gold has been making bottoms in December in recent years. But September is always a famous time when gold does well, and a famous time when stocks don't do well, so we'll see if that holds this year. Generally speaking, I definitely think there should be some kind of a strong rebound for at least a month or two.
You discussed sentiment and it's one of the worst five readings over the last decade or even two decades, and the breadth is oversold. If I was to put everything together, I think there's an above-average probability of seeing gold rebound.
Having said that, for those that are watching us on YouTube and looking at the chart, the first chart that we had out is the long-term 50-year chart of gold and gold has broken an important trend line on a long-term chart. Not that those trendlines are not the be-all or end-all of everything, but it seems like it was hugging onto that trendline since December 2015 and then again in December 2016 as it sold off into early 2017 and rebounded. And its kinda hugging there, it refused to go up and as the great Jesse Livermore used to say, "trading is not that difficult. If something doesn't wanna go up, it's probably gonna go down."
I love those lines of wisdom, as simple as they sound from his book. But since gold has broken the trendline and I doubt it's going to rebound very quickly. So like you said, maybe after we have a healthy, natural rebound from oversold conditions, the downtrend could then reassert itself. But then again, my crystal ball tends to be broken most times, so don't worry about my predictions.
So that was great. We really discussed some of those indicators and for those reading us at theatlasinvestor.com or watching us on YouTube, it's a plethora of great charts for the precious metal sector. A lot of which is signaling very bad risk conditions oversold breadth and very, negative sentiment.
One thing I would like to say, Jordan, before we get to next question is that bearish sentiment doesn't help as much in bear markets as it does in bull markets. I want those listening to keep that in mind because don't go betting the farm on a rebound because the rebound might not come. So just be careful and as I always advise, use risk management when you're trading and when you're investing. Protect your capital, and don't worry too much about your convictions. Let the market tell you what the trend is.
Moving on; what about silver? The gold/silver ratio is now at 82, Jordan. It rarely gets up here, so one could say that gold is rather expensive relative to silver, and maybe rather expensive relative to gold mining stocks. You can answer that for us.
And the second thing I'd like to ask is what happens, and have you looked at actually the correlation, to what happens to the economy and what happens to the stock markets when the gold/silver ratio gets this high also? Maybe you could fill us in on both.
Jordan Roy-Byrne: Yeah, that's an excellent question, Tiho. I personally don't put as much stock into the gold/silver ratio as the average person does. I think conventional wisdom, and it might be correct in most cases, is that when gold outperforms silver typically the economy is in less of a boom. If it's in a boom we should probably see silver outperforming gold.
It is interesting, the peaks in this ratio, you can see there was one in 2003 and then of course after the GFC in late 2008, and we've also seen a peak in late 2015 and that coincided with the last significant bottom we saw in precious metals. Now we see the ratio has surpassed 80 again.
There are some people looking at this chart and making the assumption this is a great time to buy precious metals because we're probably going to see a major bottom like in 2001, 2008 or late 2015. I'm not so sure, I believe recently the most significant high in recent decades for this ratio was around 90, which I believe was reached in the early '90's.
It doesn't tell us for sure where the next peak is going to be. Just because its gone above 80, that doesn't mean that it's making a significant peak. We don't know, it could go to 85 it could go to 90 it could even go to 95 or maybe it's going to peak in the next month or two. We just don't know.
That's why I don't put a whole lot of stock in this ratio. We've seen the economy do very well since the end of 2011, so you would think that silver should be outperforming gold. But from that point, we saw a massive peak in silver, a massive peak in precious metals but since then gold has been outperforming silver.
The idea that the gold/silver ratio rising is negative for the stock market, it may or may not be true. I just don't have that strong of an opinion on it.
Tiho Brkan: Very interesting, Jordan.
One thing that I would like to put in is that emerging markets tend to do pretty well, or at least have before. That doesn't mean they will do it again, but they bought them in 2002, 2003. They also bought them in late 2008 and they also bought them in late 2015, early 2016, and that's been every time since silver got quite cheap at 80 or above against gold.
That doesn't mean that it'll happen again. These are just correlations that people like to use and as I always say, "correlations work until they don't," and that's when they really disappoint you and that's when you end up losing some hard earned, saved cash. Investing isn't just about correlations.
Finally, the last question before we finish and what a great show today for those that are fans of precious metals, and even those that are not but would like to learn more about it. I would like to ask, you are quite connected to the industry, being a newsletter writer, and interviewer, an investor in precious metals yourself too. So you know quite a lot of people, you go to quite a lot of conferences, you have a lot of connections in the industry; so I'd like to ask you what is the mood of these savvy, so-called "experts" most of which don't make a lot of money investing in precious metals and being right. Some do by the way, but most of which actually make money in other ways.
I was just trying to mix my words here and be polite, but what is the mood amongst these people? Because usually when even they start giving up, that's when we're very close to a proper precious metals bottom and that's when gold can surprise for a few years. It can really really hard.
Jordan Roy-Byrne: My main takeaway, and obviously we shouldn't base everything on anecdotal sentiment as you know, but my main takeaway is I don't think people are giving up yet. I think from the people I follow and talk to, most people are hopeful that we're going to see a significant bottom here and a significant rally.
And of course, it depends on how you define significant. You and I might call this significant, but that doesn't rule out the fact that maybe precious metals will roll over again before the end of the year.
Obviously, some people are giving up, but I'm surprised that there's a little bit of optimism, I would say. I would also say that the large companies are probably in better shape than they were during 2014-2015. However, I don't think we can rule out some bankruptcies if we see Gold retesting that late 2015 low around $1,040/oz. Maybe it goes to $1,000/oz or even a little bit lower. If that happens then we will see some bankruptcies. I don't know if any of the really large companies are at risk but we could see some mergers out of necessity to cut costs.
Personally, I'm not that optimistic, I think this rebound is probably going to roll over later in the year. One important takeaway, Tiho, I've done a lot of historical research and over the last 60 years, I looked at 12 rate-cutting cycles for the FED or at least 12 points where they started cutting rates or restarted cutting rates. Out of ten of those twelve times, the gold stocks had an average rebound of 185%. The minimum rebound was about 54% and that rebound started an average of one month and median of two months after the FED funds rate peaked.
If we're looking for a potential catalyst, when is this downtrend going to end, and when could precious metals begin a bull market? I don't think it's going to happen until we see the FED change course and we see their last rate hike. So if you're looking to be an allocator to gold, I still think its too soon. You need to wait for the point where it looks like the FED is going to be done hiking rates.
And overall, Tiho, Gold's long-term potential depends on the economy. If the next recession we have is kind of a mild one, then we might get a little bit of a move in gold but if it's a significant one, if its a real serious one, that's where we could see much more of a move in gold beyond $1400 or $1,500/oz. Those are my big picture views as we end this year and move into 2019.
Tiho Brkan: Very, very interesting stuff Jordan, I appreciate the commentary there.
Before I let you go, I'm gonna put you on the spot and say, gold is down five months in a row and it was down recently by ten percent by mid-August, as we are doing this podcast right now. Currently its down by about seven and a half percent.
Where does it finish by year-end, negative or positive? And also is it worthy of trading on a downside or the upside or just staying in cash, if you're a precious metals investor?
Jordan Roy-Byrne: I think at this point it's going to finish the year down, I'm very confident in that I would say. It depends on this rally, Tiho. If we get a real strong rally and then there's some kind of bearish consolidation, there's some kind of setup for making a short trade, I would definitely, seriously consider that. I don't think it's worth playing on the long side right now, it probably was a couple weeks ago, as you yourself made a good trade playing the upside.
Tiho Brkan: You have to also tell them about my bad trades as well.
Jordan Roy-Byrne: I'm still waiting for a bad trade out of you. Maybe it'll be the Swiss Franc bet, we'll see, but I don't think so.
I think it's too late to play gold or gold stocks on the upside right now unless this current rebound fails and rolls over in September. That could set up a chance for a bigger oversold bounce. Now if we see some kinda bearish consolidation develop after this rally, and we see sentiment levels get a little bit more elevated, I think that would be the point to seriously consider taking a short position.
Tiho Brkan: Very interesting.
As for me, you know I hardly ever disclose what I'm doing out of respect of my clients who pay me in large sums of money to actually do the work for them, so I'm very happy with the job that I have and I wanna keep it. And two, because my crystal ball is usually broken so it doesn't work.
I have stuck my neck out recently and I have said that I am long the Swiss Franc. And I used to disclose a lot more trades before I got a lot more clients, but now out of respect for them, I have to keep my lips sealed and throw the key away, as they say. But the Swiss Franc trade, I'm very happy to disclose that. So far, so good. Since I have disclosed it, I think it's rallied for a few days, but its still early days.
As for gold, I think you just disclosed my position that I recently bought - I was a little bit early, though, but we'll see. The rebound so far is going okay, and as for gold, if I had to say whether its gonna finish up or down, I'll always say the same thing. I'll let the market tell me what's gonna happen.
Thank you for listening to The Atlas Investor Podcast. To be notified of future podcast episodes, sign up for our free newsletter and visit our YouTube Channel. Tiho Brkan offers his clients a wide range of services, including portfolio construction and wealth management, one on one consultations, global real estate opportunities, international tax planning, citizenship and residency planning and one on one mentoring. For a free consultation, visit theatlasinvestor.com and contact Tiho Brkan.