Gold just set a record. Why?

0:06Pushkin. Leprechauns across the world were delighted on Friday as gold, the shiny metal we all love, hit an all-time high,$2 ,152.30 per troy ounce. It's a bit of a surprise for us in the markets-watching world. Canonically, you'd think in a high-rates world, we should see lower gold prices. But no, gold has done just the opposite. Today on the show, we ask why. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in the New York studio, joined today by the leprechaun at the end of the rainbow, Robert Armstrong. Large, bald, leprechaun, Rob Armstrong.

0:58I think that's where you go with it. Yeah, I think we're going with that. All right, Rob, we've had you on to discuss the metal of your dreams. And like I mentioned, it is weird that we're seeing gold at all time highs, right? I mean, the first thing you learn when you read about gold as an investment asset, right, is that gold really cares about interest rates, specifically the real rate. And, you know, I think one way you can frame it is in terms of opportunity cost. Correct. So the real rate is the amount of money inflation adjusted. You know, you can just get risk free in the market and gold just sits there.

1:38Gold doesn't produce any yield whatsoever. So if the opportunity cost of just the rate you can earn on money rises, what you're willing to pay for this stuff that really, other than a little bit of industrial use and for making jewelry, just sits there, that price is going to go down. But this is all very humiliating, right? Because we've been taught that this relationship was one of the most stable relationships in all of finance. Real rates up, gold price down. And when you have jobs like our jobs, you say these sort of things again and again, and you feel very intelligent. And then you have a period like the last year or so when it just doesn't work.

2:18Yeah, absolutely. So it's very unsettling. Yeah. The past couple of years have been a bit of a roller coaster for gold. They hit a high in 2020 and then have kind of traded sideways up and down. But now we've broken the all-time high and it's worth, I think, asking why. And on this count of real rates, there is a story that can be told in gold's favor, which is that even though real rates are high, generally speaking, interest rates are high in general, probably the highest they've been since 2008. They have fallen recently, as we've talked about on the show with Rob and with Katie Martin. Rates are down a bit.

2:55People are looking at the U.S. Central Bank, seeing them talking about pausing and maybe considering cuts at some point in the future. So maybe the gold price is kind of anticipating in some way further declines in rates. Exactly. Just like much of the market, right? It appears that all kinds of risk assets, stocks, bonds, whatever, are looking at the Fed and saying, hey, rates might come down soon. Also, the economy appears to be slowing a bit, and that should kind of drag down real rates as well. So that's been one thing moving in gold's favor. And another big thing is the dollar, right? The majority buyers of gold, not the US, it's not the Europeans, it's the emerging markets.

3:35But gold is priced in dollars. Yes, exactly. Exactly. So if people who don't have dollars want to buy gold, they got to buy dollars, as it were. Right. And so a weak dollar helps the gold price. If you're a gold buyer in Kazakhstan, India, Nigeria, the dollar weakens, you have more purchasing power when it comes to buying gold. Now, to be clear, there are other offshore non-US dollar gold markets, but they're a lot smaller than the main one in London, which is all priced in dollars. So weak dollar helps. Falling rates recently helps despite the high rate levels overall. Yeah. What's next? Well, then there's the kind of the classic, and this maybe sounds like a little bit of gold buggery, but geopolitical risk.

4:19People seem to like buying gold when things get a little hairy in the world. We talk about it on the show. Whenever there's a war breaking out, it's part of the safe haven trade. It's part of the, I don't know what's going on in the world. let me just buy gold, right? And you did see some reaction to the war that broke out in Gaza in October in gold. Gold was up, I believe, 6 % in the week following the October 7 attacks in Israel. I find that one a little hard to buy in the current context. So you're telling me that the war in Gaza is pushing the gold price up, but not the oil price? Yeah. Yeah.

4:56You know, that just seems far fetched to me. I mean, I understand general insecurity world feels like a scary place, etc. But you'd think the first thing to go up if people thought the war in Gaza was a true global geopolitical problem that could spread. You would think the first price that would go up would be oil. And we really haven't seen that. No, that's absolutely right. And I mean, part of that has been there haven't been big oil supply disruptions, right? The Strait of Hormuz is open and so on and so forth. But yeah, you're right. It's always hard to tell to what extent price moves reflect geopolitical uncertainty.

5:33One thing in favor of this point, though, is there's a gold price model put out by the World Gold Council, which is the big trade body for the gold market. And they found that in October, which was a good month for gold, all things considered, there was a lot of unexplained motion that can't be explained by normal factors like the dollar or interest rates in their model, which suggests that there could be some uncertainty, some hedging in that gold price, possibly from the war breaking out. But I take your point, Rob. This is always a bit of a slippery point. And it's difficult to establish. It's just worth mentioning that this is a classic buy case for gold, right?

6:07If the world gets scarier. What about central banks? That's the one I'm interested in. So that's the fourth reason. We've got falling real rates, weaker dollar, geopolitical risk, and lastly, emerging market central banks. And this one is a lot more concrete, I think, than the geopolitical risk point, which is that for a long time in emerging markets, the central banks have started loading up on gold, a trend which has only accelerated since the war in Ukraine, the big sanctions regime that the West put on Russia, which has incentivized a lot of emerging markets, right, who consider Russia a pure economy to say, I mean, could we be next?

6:42Maybe we should get out of dollars at least a little bit. So the idea is that owning dollars puts you under the thumb of US hedge money or something like that. It's a weakness to be too exposed to dollars in your reserve assets. I think on the margin, that's right. And the other part is that the US is of, in some ways, decreasing global trade importance, right? As China's risen and India's rising, taking up a larger share of the economy. These emerging market central banks, while they still are holding a ton of dollars to be very, very, very clear, you just on the margin don't need as much, right?

7:20So where do you want to put that money? Well, gold's a half decent option. If you're the central bank, you're not chasing returns. In a way, that's a commentary on what crap non-dollar fiat currencies are. It's like, we have a bunch of reserves in dollars. How are we going to diversify? Well, God knows we don't want euros or renminbi or yen. So I guess it's gold. Okay. You know? No, that's right. That's a good point. And, you know, central bank demand has been hitting records again and again and again and again in the last several quarters. 2022 is a record year for central bank purchases of gold.

8:012023 is on track to have yet another record year. I think we're up 14 % year to date on the record year last year in gold purchases by central banks. So anyway, this is a big new structural source of gold demand. And I think between these four things, real rates, US dollar, geopolitical risk, emerging markets, central banks, you've got a pretty complete story, Rob. This raises a natural question. What is in your portfolio? Well, I've got about$50 in my portfolio, 25 are in Bitcoin, 25 are in gold. It's done very well recently, actually. So you're a gold believer. I don't know. I didn't even know you could buy gold in$25 increments, but it's like one share of the gold ETF.

8:40They sell fractional gold shares now. Yeah. So does this rally in the price of gold make you feel like you want to own even more, like you want more exposure to gold? Are you a gold bug now, Ethan? You know, I don't know about a gold bug, but I kind of see the case for it as a diversifier. Yes, there's no yield, but look at what the price did in the past three years. It was flat while everything else was taking a bath in 2022. Yes. It's an uncorrelated source of return. Now, to be clear, the long-run return is not excellent. Yeah. No, this is what I'm saying. It's like half that of equity. So if you have a long horizon, I don't understand why you'd want to own this stuff.

9:19I mean, this is a very familiar point, but let me make it just the same. It's the barbarous relic. This is an inert, soft, shiny metal with a modest amount of industrial demand, some jewelry demand, but it is not a productive asset. Right. And what you want to own as an investor are things that compound over time. Right. They earn money, reinvest money, earn even more money. And gold just doesn't do this. So and in this sense, it's a bit like other commodities, iron ore, oil or whatever, except it doesn't even have the productive uses those commodities have. So I'm kind of anti commodity as an investment for most people or for non experts.

10:06And I guess I'm particularly despite being a large leprechaun, I am particularly anti gold. I want my my pot at the end of the rainbow is full of stocks. Your pot is the Vanguard S &P 500 ETF low expense ratio. A lot of people who get over the rainbow are disappointed to find that out. But I'm telling you, I just don't understand the case for gold, really. Let me make the opposite case, right? In this millennium, it's been a pretty good market for gold. The compound annual growth rate since 2000 has been about 9 % versus around 5 % on the S &P. To be clear, if you base against 2000, you get some of the dot-com high valuations in stocks.

10:49But the point stands, 9 % for gold nominal return, really not bad at all. Over 20 years. Over 20 years. Yeah, it is not bad. And I'm surprised to hear that, actually, I'll say. I'm surprised that over, no matter what you're, and 2000 is a terrible starting point for stocks. But even given that, over 20 years, I'm surprised to hear that gold has beaten stocks. Yeah. I would hypothesize part of what you might be seeing there is the rise of Chinese wealth. Yeah. Because individuals in China became a lot richer over that period. And that is a country where people are going to want a store of wealth over which they have great controls.

11:32Yeah. You can pick it up yourself and go someplace. I mean, to put not too fine a point on it, it's not a democratic country with the rule of law. And in countries like that, what you want is assets that are really yours, that you can move, hide, protect from taxes, whatever. Yeah. And there's also the point that gold is a big cultural role in China. Yes. Very common as a gift for big life events, you know, weddings, newborns. And so as the country's gotten bigger, it's become the number one gold market in the last 10 years or so. I mean, we can argue about what the long-term prospects are for the Chinese economy, but presuming that a country of a billion plus ambitious, smart Chinese people in the long run will get richer, that's part of the bull case, I think, for gold.

12:19Yes. And also the fact that it has a different return profile fundamentally makes it helpful as a diversifier, right? Not 50 % of your portfolio like me, but if you want to put a 5 % allocation, 3 % allocation, that doesn't seem crazy. Or perhaps part of your larger commodity strategy. That's the case for commodities in general, right? Not just gold. Yeah. Is their source of returns are kind of outside the normal realm that we think about stocks and bonds and the cycle and the earnings. And it's about like, what are we going to build stuff with? Or what do we want to make jewelry out of? Here's a question for you, though.

12:56If you're going to own gold, you know, 5 % of your portfolio, do you want the physical stuff like in your house? So when the ball goes up and there's chaos in the streets and cats and dogs living together and all this stuff, you can actually grab it and go. Is that the idea here? You know, it's like those ads on late night TV with Donald Trump is selling you gold coins. The argument that this is an asset that is growing in importance in an unstable world. Do you want to go all the way and, you know, have bullion hidden in your mattress? Well, I mean, you last. No, it's saying like if you're going to go, go all the way.

13:38Yeah, I hear that. I hear my view is there are some risks that are too big to hedge. Civilizational collapse may be one of them. and the gold bars buried in your backyard may or may not help you if law and order breaks down, you know, across the world or there's like a nuclear holocaust. Yeah. And if somebody finds out you have gold in your backyard, law and order may break down in your backyard for that specific reason. That's exactly right. Also, just like I don't trust my ability to bury and retrieve the gold bars. I feel like that. I can't find my wallet most mornings. Oh, yeah. Yeah. Yeah.

14:13So like, of course, I'll forget where I hid the gold. Yeah. Listeners, every time you see a rainbow, there is a Rob Armstrong at the end of it with his pot of low expense ratio S &P 500 ETS. It's not a myth. It's real. All right, Rob, we'll be back in a moment with Long Short.

14:34Welcome back. This is Long Short, that part of the show where we go long, our favorite things in the world, and short, our least favorite things. Rob, I am Long Low-Fee Larry. Wow. Low-Fee Larry. Are you talking about Larry Bird? Larry Fink, CEO of BlackRock. Larry Fink. Oh, the second most important Larry. That's right. The listeners will probably know there's been a big ESG environmental social governance investing backlash in the U.S. led by the Republican Party. And, you know, I think, Rob, our view is like ESG is dumb. The backlash is dumb, too. I really like this. This isn't a story from our colleagues, Brooke Masters and Patrick Temple West in the FT.

15:13They talked to North Carolina's Republican treasurer who has called for Larry Fink's resignation. Quote, Larry Fink has done nothing over the past year, but tried to divert people's attention from him getting caught politicizing pension money. Dale Fowell has called for the chief executive to be sacked, but has declined to pull his state's money out of BlackRock, citing its attractive low fees. Chef's kiss. That is perfect. It just shows how the whole debate top to bottom is nonsense. ESG, nonsense. Any ESG, nonsense. It's just the whole thing is like a Kabuki performance. Kabuki theater top to bottom.

15:55That's right. Rob, are you long or short something? I am short. And this is not as grim as it sounds. I'm going to be a bit short. The U.S. job market. We have been creating 200 ,000 jobs a month in this great country, which is really remarkable. We've talked on this show and in the newsletter about how there's very clear signs of slowing in the economy, not to say we're going into recession, but significant slowing from a red hot third quarter to a kind of modestly growing fourth quarter and into the next quarter. But yet we crank out this relatively high level of jobs every month. And I think those things don't go together.

16:40And we're going to see we have some jobs numbers coming up in a few days. I think we're going to see the trends start to go down. And again, not into recession, but the days of 200 ,000 jobs a month numbered. We are all waiting with bated breath for Friday's jobs report, which will hopefully give us more insight on kind of where this economy is and if we're slowing down. Now that I've jinxed it, it's going to be 300 ,000. But yeah, that's my that's my role here. Hey, but that would be good news. Good news for the American worker. Good news for the American economy. Indeed. All right. Thanks, Rob, for being here.

17:12We'll have you back soon. And listeners, we're back in your feed on Thursday with another episode of Unhedged. Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Jacob Weisberg, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.