How to Find Opportunities from Blood, Debt & Fears

How to Find Opportunities from Blood, Debt & Fears

By Frank Holmes, CEO and Chief Investment Officer
U.S. Global Investors

My long-time friend and mentor Seymour Schulich forwarded an email to me that puts today’s U.S. government debt mountain startlingly into context. By removing several zeros, one can place the debt situation in terms we all can understand—that of a family’s income and expenses.

A family who takes in an annual income of $21,700 but spends $38,200 will soon be in dire straights. The large outstanding balance on the credit card only exacerbates the situation. Clearly, spending cuts need to be made, but eliminating only $385 from the family’s budget would be a drop in the bucket. Either a substantially higher amount of income needs to be made, or the family will have to learn to live with less.

Of course, the fiscal situation is more complicated when it comes to a “family” of 311 million. It is only one part of a large conundrum for the global economy.

Gold is “Sole Beneficiary” in this Economy

Don Coxe, global portfolio strategist, points to the Shanghai Composite Index and Bombay Sensex which are currently at one-year lows, indicating that investors are not feeling confident even in these relatively strong markets where GDP is growing. In this environment, Coxe believes gold is the “sole beneficiary.”

We’ve discussed several times that another driver of gold prices has been real interest rates. Take a look at the chart from Gold Stock Analyst (GSA) depicting the price of gold going back to 1968. In each case when real rates (calculated by subtracted the 12-month moving average of the year-over-year change of CPI from the 12-month moving average of the 3-month Treasury bill) went negative—in the 1970s, the first years of the new decade, and off and on from 2008 until now—gold has had a dramatic rise in price.

A negative real interest rate means that a hypothetical $100 investment in a T-bill is worth, for example, $98.90 a year later, i.e. you’ve lost purchasing power. Investors seeking yield have fled to gold in these instances.

Conversely, when interest rates turned positive in the 1980s, gold trended downward for the next 20 years.

Despite gold’s dramatic bull run over the last 10 years, the yellow metal is only twice as high as its 1980 price. In comparison to other economic yardsticks since 1980, this is miniscule. Ian McAvity, editor of Deliberations on World Markets, says that federal debt, the S&P 500 Index and even GDP has grown much faster than gold over that same timeframe.

The gross U.S. federal debt of $14.3 trillion is 17 times its 1980 level. In 1980, the S&P 500 was at 105; today, it trades around 1,100. A gold price of $1,808 seems paltry as it is only 2.5 times the 1980 high of $738.

McAvity extrapolates the relative growth rate of the yellow metal, indicating that if gold doubled from its current high, it “would nearly ‘catch up’ to GDP, while it might take a quadruple to match the S&P, or even a six-fold gain from here to catch the growth of debt.” Multiplying the largest of these figures by the current price of gold means prices could theoretically go to $10,800. By these standards, gold is hardly a bubble.

Gold these days has become so “legitimized,” helped by negative real interest rates, that the metal now directly competes with stocks for a share of investors’ portfolios, says the GSA. We applaud this development, as we have always thought investors should allocate a small portion of their portfolio to gold. However, we argue that a gold ETF is not always a wise choice, particularly when it is treated as a short-term trade, like a stock.