The U.S. dollar isn’t the only asset gold has outperformed during recent decades. The yellow metal has also seen periods of relative strength against the S&P 500. This chart from Gold Stock Analyst pits the performance of gold bullion against the S&P 500 since 1971—you can see that gold immediately rallied following Nixon’s announcement before peaking at $850 an ounce in 1980. At that price, one ounce of gold was 7.6 times greater than the S&P 500, according to Gold Stock Analyst. Gold’s relative performance then declined for the next 20 years, with the S&P 500 taking the lead in 1992 and peaking at 5.3 times the value of gold in 1999. Currently, gold’s value is roughly 1.6 times greater than the S&P 500.
What drove gold’s relative underperformance from 1980 to 1999? It was a shift in government policies, which have historically been precursors to change—a key tenet of our investment process.
Gold Stock Analyst points out that Federal Reserve Chairman Paul Volcker began steering the U.S. economy toward positive real interest rates in 1980 and Volcker’s goal was met in 1992—the same year the S&P 500 overtook gold.
In order for gold’s relative value to return to 1979-1980 peak levels of 7.6 times the S&P 500, Gold Stock Analyst’s John Doody says gold prices would have to hit the $10,000 mark. Obviously that scenario is unlikely, but it does put all this “gold bubble” nonsense into perspective.
One point to pop the “gold bubble” talk is that negative real interest rates are poised to stick around for a while. We’ve previously discussed that negative real interest rates—one of the main drivers of the Fear Trade—have historically been a miracle elixir for higher gold prices. The magic number for real interest rates is 2 percent. That’s when you can earn more than 2 percent on a U.S. Treasury bill after discounting for inflation. Our research has shown that commodities tend to perform well when rates fall below 2 percent.
Take gold and silver, for example, which have historically appreciated when the real interest rate dips below 2 percent. Additionally, the lower real interest rates drop, the stronger the returns tend to be for gold. On the other hand, once real interest rates rise above the 2 percent mark, you start to see negative year-over-year returns for both gold and silver.
It’s important to point out that it’s the political policies not political parties that drive this phenomenon. During the 1990s, when President Clinton was in office, there was a budget surplus and investors could earn more on Treasury bills (about 3 percent) than the inflationary rate (about 2). This gave investors little incentive to embrace commodities such as gold, and prices hovered around $250 an ounce.
Since 2001, increased regulation in all aspects of life, negative real interest rates, welfare and entitlement expansion funded with increased deficit spending have created an imbalance in America’s economic system. It’s this disequilibrium between fiscal and monetary policies that drives gold to outperform in a country’s currency. Today, the Fed capped interest rates near zero back in 2008 and the federal budget deficit has ballooned to $1.4 trillion. In fact, both the deficit as a percentage of GDP (negative 11 percent) and federal government debt as a percentage of GDP (nearly 65 percent) are at the highest levels since 1950, Citigroup research shows. This has helped fuel gold’s rise through $1,000, $1,500 and now $1,800 an ounce.
