Good Morning. Yesterday’s good results from Target — a company that has not performed perfectly recently — put another nail in the coffin of the “weakening US consumer” theory. There is a Target store in Jackson Hole, as it happens. Maybe Jay Powell should stop in? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.
Hedging with gold
How good a hedge is gold? What does it hedge, exactly, and how?
Over the past 20 years or so, gold has performed much better than the other classic diversifying hedge for an equity portfolio, bonds:
Notice, though, that gold is not a source of consistent returns. Look at the painful years 1997-2005 and 2012-2016, for example. If what you want from your non-equity allocation is stability, look elsewhere.
But maybe I don’t need my equity hedge to provide steady gains. What I need is for it to perform particularly well at moments when equities perform terribly. Gold has done well on that front recently. Here are total returns for the S&P 500, gold, Treasuries and inflation-indexed Treasuries in four recent market spasms:
Gold was a better hedge than bonds in the great financial crisis, at the end of 2018, and in the 2022 inflation/rates rout. Only in the dotcom bust were bonds superior, and gold was still up then. Gold is a quite good asset for risk-off moments.
Only one thing rankles. In 2022, a big part of the market’s problem was inflation, the very thing that gold is most prized for protecting against, and yet gold fell (less than bonds, but still).
This is an important point. In response to yesterday’s piece, many readers argued that gold is a special kind of currency, a store of value that is not the liability of a feckless government. One commenter wrote that the “gold price is not rising?.?.?.?[instead]?all fiat currencies are devaluing against gold due to the endless inflationary money printing binge”; another said: “You hold [gold] to preserve your wealth while pounds and dollars are debased year-in, year-out by M2 inflation.”
This is not quite right. Over the span of decades, gold does hold its value against inflation. But in a given year, or even over several years, it does not correlate at all neatly with inflation or anticipated inflation. There are a couple of ways to see this. Here is US M2 money supply growth and the increase in the gold price:
The gold price swings wildly above and below the rate of money growth. In 2020, gold jumped when the money presses started to hum — but then went sideways for several years while the printing continued.
Here is a chart of year-over-year changes in US CPI and in the gold price. I have used different axis values, magnifying the smaller changes in CPI, to make it easier to compare them to the gold price changes:
The gold price clearly responds to inflation, but in a very inconsistent way. There are big increases in the price at times of low inflation, and conversely. In the long term, gold is a good store of value in the face of inflation. In the short and medium term, it is often a pretty bad one.
Still, I’m warming up to gold (though maybe not at $2,500!).
Gold miners
Here’s an appalling chart:
That is an ETF that holds a diversified basket of gold miners compared with the price of gold. Since 2008 or so, the underperformance of the miners versus the commodity has been very, very bad. Why is this? There seem to be two basic explanations here, one longer-term and one shorter-term.
There is a stereotype about the kinds of people who operate mining companies. They are thought to be wildly optimistic, ever keen to start the next big project, and to care little for the niceties of making shareholders richer. They end up digging a lot of big holes in the ground and generating poor returns.
Jon Hartsel of Donald Smith & Co thinks that the stereotype has had a lot of truth to it in recent decades. He points out that between 2011-15 the five biggest gold miners took $80bn in impairments on mergers they overpaid for and on projects with cost overruns. Investors won’t buy mining stocks until they are sure management teams are not up to their old tricks. Investors want free cash flow, not more mines.
The North American shale oil industry used to have the same reputation for capital destruction as the gold miners do now, but that has changed. So there is hope. And Hartsel points out that one company that has demonstrated disciplined capital stewardship, Agnico Eagle, has managed to do quite well relative to gold:
Hartsel writes: “Agnico Eagle?.?.?.?trades at a premium valuation due to its excellent record on capital allocation and operational execution?.?.?.?but the industry as a whole is allocating capital more rationally as it has learned from mis-steps from prior cycles.”
The shorter-term problem for the miners, according to Anita Soni of CIBC Capital Markets, was that operating cost inflation from 2020 to 2022 was higher than inflation in the gold price, causing margins to compress. She is hopeful that the squeeze may be subsiding, and thinks industry costs declined between the first and second quarters, even as the gold price rose.
This is certainly visible in, for example, Barrick’s recent results. But it will take more than a quarter or two of expanding margins for the industry to regain investors’ trust.
Payroll report revisions
Yesterday the Bureau of Labor Statistics revised the employment numbers from April 2023 to March 2024 down, by 818,000 jobs. One thing that leapt out to us was the major downward revision in professional and business services — 358,000 jobs, or 44 per cent of the total revision. We knew that some consulting firms were downsizing, but not that much!
Stephen Brown of Capital Economics provides an explanation. The reason the BLS revises its numbers every year is that its monthly results use business surveys, which do not capture employment changes from the creation of new firms and the dissolution of old ones. To compensate in its monthly releases, the BLS uses what it calls the “birth-death model” to make estimates, which it can verify a year later with unemployment claims information. From Stephen:
Although professional services make up only 15 per cent of total payroll employment, the BLS assumed that professional services accounted for a disproportionate 25 per cent or so of job creation among newly established firms in the year to March. That?.?.?.?left scope for a larger downward revision in the case that the birth-death model was overestimating employment gains.
The BLS had reason to believe that professional services would punch above their weight — between 2012-22, the amount of people employed in professional services increased by 33 per cent, behind only construction and transportation, driven in part by the founding of new companies. But the model was clearly too optimistic.
Have high interest rates somehow prevented white-collar professionals from setting up new companies? Or is something else going on?
(Reiter)
One good read
Convention clothes.
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