Investment Idea

Gold vs Stocks in an Era of Stimulus

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Mikael Syding
06/02/2023 | 5 min read
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Since March 2000, the OMX index has increased by almost 50 percent. In the same period, gold rose 700 percent from SEK 80/gram to today's SEK 640/gram. Will it be just as good in the next quarter of a century?

If you choose the measurement period just a few months differently, the OMX index actually only increased by a minimal 15% overall over 22 years, from March 2020 to September 2022. Fortunately, an index owner received dividends in the meantime, since the share prices themselves thus only increased by barely measurable 0.7% per year. However, the dividends of a few percent a year only compensated for the inflation, so an OMX index investor in practice did not move in real terms for these 22 years.

The small rise in the index that took place after all was only made possible by an extremely expansive monetary policy with zero interest rates about half the time. The latter is hardly something you can hope for in the future, rather the opposite: that the interest rate tailwind turns into a headwind. Zero interest is in itself an unnatural extra stimulus in a growing economy. Falling interest may be even more strange and stimulating, but was seen as necessary due to an increasingly weaker underlying economic growth and low rate of price increase.

Deflation has now turned into inflation, partly due to one-off events such as war and pandemic stimulus, but also as a result of deglobalisation and environmental work. There is an end to cheap labour, cheap energy and cheap raw materials. This means higher prices for everything and thus also more historically normal interest rates of at least a few percent. The US central bank has already shown the way with a key interest rate of 5 percent as a countermeasure against US Consumer Price Index (CPI) inflation of 5-9 percent.

Compared to falling interest rates to zero, rising interest rates from zero to 5 percent represents a huge headwind for consumers, businesses and governments. The space has been greatly reduced for consumption and investment as well as for grants and subsidies. As a Swede, the higher mortgage interest and winter's electricity bills are clearly felt in the wallet, and it doesn't get any better if the grocery bag has become 20% more expensive at the same time. The situation has just begun to start a spiral of increased caution, reduced consumption, reduced investment, increased unemployment, etc. On top of it all, Sweden's house prices have fallen by 20%, fastest in the world according to some measurements. Also, don't forget that interest rate increases have a lag of more than a year. Since we are still raising interest rates now in the first quarter of 2023, the negative effects will not hit with full force until 2024. With a bit of luck, there will also be a cold winter and thus potentially an even worse energy crisis than this year, depending partly on the temperature, partly on the development in Russia and the Middle East.

The only thing really still keeping hope alive is the record-high stock market, where buyers are trying to quickly recoup last year's correction of -21 percent. The hope is mainly for a "central bank pivot", i.e. a turn to lower interest rates. What the stock market then misses is partly that Fed Chairman Powell would prefer to end the constant talk about the Fed always saving the stock market, partly that a pivot will only come if the economy is so weak that there will be no inflation after all. In addition, the market participants seem to have forgotten that the stock market usually falls sharply and does not bottom until barely a year after the first interest rate cut.

Considering that the US stock market is still more than twice as high as its historical average (calculated on Price/Sales), and that several decades of strong tailwinds have now been replaced by headwinds, I don't know what to base a positive market view on. The conditions for growth are lower and even just a normalization of the valuation multiples clearly points further downwards for the market. Furthermore, right now the Fed can hardly lower the interest rate, and when they do lower it is because the situation is even worse, which as I said usually means crashing markets. Now, the OMX is not the same as the S&P500, but the two stock markets usually move in tandem. When the S&P crashes, so does the OMX.

In conclusion, an equity investor should not expect as "good" a development as in recent decades. On the contrary, it can be quite a bit worse due to a more demanding starting point. Then there are probably better ways to manage your capital than just blindly buying and keeping a basket of shares. Could gold or mines be an option?

Gold thus increased to eight times the starting price while OMX was almost stationary. Can it be repeated? What are the conditions for gold to continue to outclass such productive assets as a country's top company?

To begin with, it is not the assets that should be outperformed, but the shares, i.e. the price of the assets. Given that a strong tailwind was required to bring OMX to a standstill, a strong headwind would at least mean a substantial downward correction for some period. It is enough if that period is a single year, for example the next twelve months, to be able to use it to switch feet again from gold to shares - on the stairs up to Lustiga Huset, which I usually liken it to in the Financial Course.

The question is rather what can cause the gold price to at least not fall as much as stocks during the same period. The answer lies in the characteristics of the same period that we have behind us, ie an underlying weakness in the economy's ability to achieve increasing private incomes and growth. The absence of growth "forces" stimulus, but stimulus does not create sustainable growth, but only leads to further economic inefficiency and more currency. This currency must be distributed over time according to the actors' preferences between e.g. shares, gold, housing, cash etc. The relationships vary, of course, but they oscillate around their average value. Furthermore, they tend to trend in long cycles, e.g. as we saw for a while how stocks took over from gold and are now in the middle of a trend where gold is about to regain its normal weight in an asset portfolio.

All gold is worth in round numbers $10T, all stocks $100T, bonds $300T, real estate $300T, cryptocurrencies $1T. Just a small flip from "expensive" risk assets like stocks to "safe" real assets could lift gold from 10T to 20T, and speculation about future wealth could easily lift cryptocurrencies from 1T to 5T. For a long period, Buy And Hold growth assets have been seen as the only option, TINA (meaning “There Is No Alternative”). But as more passive assets such as gold have reached a relevant size, gold is also becoming an increasingly viable investment.

Momentum creates momentum, the greater the market value of gold the greater share it can be allowed to take in the portfolios. In addition to that, it can also be argued that 10% uncorrelated assets in one's portfolio, such as gold and cryptocurrencies, leads to better portfolio characteristics - ie better relationship between return and risk. These lines of thinking are heard more and more often, especially when the stock market is going bad. If I am correct in my stock market scenario, it could create a perfect storm for the price of gold, especially relative to stocks. If the gold e.g. doubles in price and shares fall by only 30% in the meantime, you get three times as many shares for the money when you switch feet on the Lustiga Huset stairs.

This doesn't just apply to gold. It's the principle that's important: not to stay and sputter on one and the same step all the time like a fish on dry land. The relative movements become extremely important when the quantities are stationary in real terms over time, i.e. as OMX did from 2000 to 2022 and may well do for just as long. In the meantime, gold should also remain stagnant in real terms. It's just a yellow stone after all. But the relative movements in the meantime work like the steps at Gröna Lund. You'll launch like a rocket if you just think a little.


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