With the Market Mania Is There Sanity in Gold?

With the Market Mania Is There Sanity in Gold?

Driven by U.S. Dollar Weakness, Gold Market Gained in January

The gold price continued to move higher after becoming oversold ahead of the December 13 Federal Reserve (the "Fed") rate announcement. After reaching a 17-month high of $1,366 per ounce on January 25, gold finished the month with a $42.10 (3.2%) gain at $1,345.15 per ounce. The move to new highs was driven by U.S. dollar weakness. The U.S. Dollar Index (DXY)1 sunk to lows last seen in 2014, due to currency comments and trade tariffs announced by the Trump administration, strong economic data from the Eurozone, and European Central Bank (ECB) minutes that suggested it might move sooner than expected to unwind its bond buying program. The last days of the month brought some weakness for gold as markets begin to see increasing chances of a Fed rate hike in March.

Gold Stocks Consolidated and Valuations Remain Attractive

Gold stocks seem to be consolidating after outperforming gold in December. The equities trailed gold bullion in January as the NYSE Arca Gold Miners Index (GDMNTR)2 advanced 2.0% and the MVIS Global Junior Gold Miners Index (MVGDXJTR)3 declined 1.6%. Many companies reported positive fourth quarter and year-end production results. Due to the muted reaction in their share prices, valuations continue to track below long-term averages. In the current environment, gold stocks are not receiving much attention as investors focus on the broader stock market, cryptocurrencies, and other commodities.

Rising Bond Rates, Full Employment, Global Growth Spur Inflation Expectations

A surge in interest rates was also supportive of gold in January, as 10-year U.S. Treasury rates advanced to their highest level in nearly four years. In 2017, rising bond rates proved to be a headwind for the gold price. However, since mid-December rates have risen in tandem with the gold price. We believe this is because the latest increase in rates has been driven by inflation expectations rather than activity from the Fed. It seems the market is beginning to view full employment, tax stimulus, and synchronized global growth as inflationary. Commodities have been trending higher. There is also growing potential for protectionist trade policies and purchasing managers globally are finding it increasingly hard to fill demand. There is a nationwide truck shortage in the U.S. and The Wall Street Journal reports strong wage growth in several metropolitan areas.

Structural Changes in Economy, Demographics Likely to Mute Inflation

While inflation could pick up, we do not believe it will reach levels that might drive gold. In fact, we believe there have been structural changes in the economy that mute the inflationary cycles that goods and services experienced in the past. Globalization, immigration, and technology have evolved to enable companies to produce as much as needed to meet demand. Bottlenecks do not last. Everything has become commoditized. Competition is intense. E-commerce drives retail. Low wage immigrants take unwanted jobs. Many companies are announcing one-time bonuses and other perks with the new tax cuts. At this time, we have not heard of any company announcing permanent wage increases. Contracting, outsourcing, and automation keep wage growth low. Demographics are also anti-inflationary as boomers move into harvest mode. For years the Fed has failed to raise inflation to its targeted 2% by flooding the economy with liquidity. That liquidity, instead of raising consumer price inflation in the real economy, has generated asset price inflation in the financial economy — stocks, bonds, real estate, cryptocurrencies, art, etc. Now the Fed is tightening. Gold or gold stocks are seen as a real economy inflation hedge, however we do not see it as a significant driver in 2018.

Related: The Potential and Challenges of Digital Assets and the Bitcoin Boom

Late-Stage Economy Has Entered the Mania Phase

In our December commentary we talked about the risks of a downturn in a late-cycle economy, as well as the possibility of a market decline that morphs into a debt-driven financial crisis. We now believe the markets have entered the mania phase of this cycle. A series of experiments by Harvard and MIT grad students reported in The Wall Street Journal show that when rates are low, investors' appetite for risk increases beyond what seems logical. It is hard to characterize the price action of cryptocurrencies as anything but a mania. The High Tech Strategist newsletter quotes economic historian Charles Kindleberger: "At a late stage, speculation tends to detach itself from really valuable objects and turn to delusive ones. A larger and larger group of people seeks to become rich without any understanding of the processes involved".

Across other markets the mania is broadly based. Goldman Sachs estimates that the prolonged bull market in stocks, bonds, and credit has left a measure of average valuation at the highest since 1900. The Dow Jones Industrial Average (DJIA)4 had the most new highs ever recorded in 2017 and saw its longest run without a 3% correction. The S&P 500 Index (SPX)5 has broken similar records. Margin debt on major stock exchanges tracked by the Financial Industry Regulatory Authority (FINRA) increased 21% in 2017. The Wall Street Journal found the outperformance of growth stocks in January was the most in such a short period aside from the last year of the dot-com bubble. Manias rarely end quietly. When they end, they typically crash. They can last for years and we speculate that the current mania might run its course into 2019. Former Chairman of the Federal Reserve Alan Greenspan famously recognized "irrational exuberance" in the markets three full years before the peak of the tech bubble in 2000.

As Mania Reaches Extremes, A Look at Gold's Performance Across Cycles

Gold is recognized as a hedge against financial stress and tends to outperform other investments in severe market downturns. In a June 2017 report, ETF Securities looked at gold's performance during drawdowns of over 15% in the S&P 500. Since 1982 there have been ten such S&P drawdowns that averaged -24.4%. The corresponding average performance of gold was +7.2%. A 2011 bulletin by Lombard Odier looked at gold real returns in major global banking crises since the Great Depression. They found five banking crises lasting from 12 to 57 months during which the real performance of gold averaged +20.6%.

Most people reading this report carry the Tech and Housing mania in their financial memory. In the table we broadly characterize the markets since 1995 as bull/manias, crashes, and recoveries to see how stocks and gold investments behaved in each. We examine the returns of the S&P 500, gold, the Philadelphia Stock Exchange Gold and Silver Index (XAU)6 and the actively managed VanEck International Investors Gold Fund (Class A - INIVX).


Gold investments do very poorly when the bulls are running at full speed. Investors generally feel no need for a safe haven7 in a market that rises relentlessly. However, gold and gold stocks are performing somewhat differently in the current mania. Substantial losses occurred in the cyclical bear market in gold from 2011 to 2015 when gold and the XAU declined 41.4% and 76.1% respectively, while the S&P 500 Index gained 98.4%. As the markets now reach their mania phase, there is no longer heavy selling pressure on gold and gold stocks. In fact, they have stabilized with nice gains in 2016 and 2017. Also, there are other factors such as the U.S. dollar, real rates, and geopolitical risks that have recently influenced the gold price.


Gold is the clear winner in a crash, fulfilling its role as a hedge against financial turmoil. The performance is mixed for gold stocks. Many gold stocks did very well in the Tech Crash, but suffered losses in the Housing Crash. We believe industry fundamentals were the reason for their poor showing. China was driving a commodities super-cycle in which costs rose relentlessly. Shortages in labor, equipment, and materials along with record energy prices drove double-digit cost inflation. Margins were squeezed and companies failed to meet market expectations. Performance was also compromised by poor management decisions. As a result, gold stocks suffered deratings in 2008 and 2011 when their value relative to gold diminished substantially. We believe gold industry fundamentals today are more like those around the time of the Tech Crash. Companies have regained efficiencies and are well managed, standing to fully benefit from any rise in the gold price.


Both gold and gold stocks outperformed in the recoveries. Many gold stocks exhibit exceptional leverage to the gold price in the recovery phase. When companies are well managed and costs stay contained, they bring earnings and resource leverage. In addition, there is a scarcity component. Capitalized at roughly $260 billion, according to VanEck research, the global gold industry is relatively small. When investors decide they need a safe haven, there may not be enough gold stocks to go around.

Download Commentary PDF with Fund specific information and performance


1U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar. The DXY does this by averaging the exchange rates between the U.S. dollar and six major world currencies: Euro, Japanese yen, Pound sterling, Canadian dollar, Swedish kroner, and Swiss franc.

2NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.

3MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company's revenue from gold or silver mining when developed, or primarily invest in gold or silver.

4The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.

5S&P 500® Index (S&P 500) consists of 500 widely held common stocks covering industrial, utility, financial, and transportation sectors.

6The Philadelphia Gold and Silver Index (XAU) is an index of thirty precious metal mining companies that is traded on the Philadelphia Stock Exchange.

7Safe haven is an investment that is expected to retain its value or even increase its value in times of market turbulence.

Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.

Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index's performance is not illustrative of the Fund's performance. Indices are not securities in which investments can be made.
Ed Lopez
Alternative Strategies
Twitter Email

Founded in 1955 by John C. van Eck, Van Eck Associates Corporation was among the first U.S. money managers helping investors achieve greater diversification through globa ... Click for full bio

Most Read IRIS Articles of the Week: Feb 19-23

Most Read IRIS Articles of the Week: Feb 19-23

Here’s a look at the Top 11 Most Viewed Articles of the Week on IRIS.xyz, Feb 19-23, 2018

Click the headline to read the full article.  Enjoy!

1. Don’t Get Pinged by the Social Security Earnings Limit

I’d like to introduce you to Peggy. Born in 1956, Peggy will be 62 in 2018. She has worked in retail her whole life, the past twenty-five years spent in management. Peggy divorced from her husband 14 years ago, is still single and has no children. — Dana Anspach

2. We're Back to “Bad News is Good News” and “Good News is Great News”

This week the markets shrugged off last week’s fears and went back to the slow and steady melt up, despite economic news that looked likely to once again rock the boat. — Lenore Elle Hawkins

3. Q1 2018 Factor Views

Themes established in 2017 across a wide range of markets and factors continued to resonate through the fourth quarter. Economic growth was strong and supportive of equity markets across the globe, a range of volatility measures reached all-time lows, and business and consumer sentiment remained elevated. — Yazann Romahi and Garrett Norman

4. A Beneficial Basket of Commodities

Advisors and investors that feel they are hearing more and more about commodities and the corresponding exchange traded products in recent months are right. That is a natural result of dollar weakness and yes, the greenback is floundering again in 2018. — Tom Lydon

5. 3 Trends Shaping the Future of Asset Management

As the industry works to cope with new regulation, wades through an outpouring of new products, learns to satisfy investors’ shifting priorities and manages the active-passive debate, the viability of business units will be questioned, and at times radical measures will be taken. Peter Hopkins

6. 5 Ways Advisors Leave Money on the Table, and What to Do About It

My hope is that this article points out some opportunities for you to make more money and serve your clients at a higher level and that you decide to do something about it. — Bill Bachrach

7. The Market Has Gone Wild! Is It Time to Change Your Investment Strategy?

Whether the market is flying high or taunting your emotions with new lows and some bumpy volatility, here are four things every investor should keep in mind ... — Lauren Klein

8. How to Deepen Client Relations and Capture New Business Using Engaging Content

Why financial advisors NEED to understand much more clearly the power of good digital market. With tools like AdvisorStream, it’s easier than ever to get the content you need to drive leads and referrals today! — Kirk Lowe and Matt Halloran

9. Three Ways The Most Successful Gain Big Attention

How do some firms and ideas go from nowhere to everywhere in a few short months? All of a sudden a restaurant becomes popular, a gas station gains a cult following, or a Broadway show becomes too popular to get a ticket for years. — Maribeth Kuzmeski

10. Who Are the Hottest FinTech Firms and Influencers Around the World?

"Worldwide, $27.4 billion poured into fintech startups in 2017, Accenture reports, up 18% from 2016. With so much in play, it’s not surprising that 22 companies are new on this, the third edition of our list."  — Chris Skinner

11. The New Stock Market Normal Is Not What You Think!

Many sensational headlines have been written the past few weeks about market declines, but two things have increased for sure: the viewership and the ad revenues of financial media organizations — Preston McSwain​​​​​​​

Douglas Heikkinen
Twitter Email

IRIS Co-Founder and Producer of Perspective—a personal look at the industry, and notables who share what they’ve learned, regretted, won, lost and what continues ... Click for full bio