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Stepan Lavrouk
Stepan Lavrouk
Articles (391) 

Investors Should Consider Adding Gold to Their Portfolios

The precious metal offers a valuable hedge against uncertainty

January 19, 2020 | About:

With the major stock indexes reaching new highs every day, some investors may be questioning the wisdom of buying expensive assets in the hope they will become more expensive down the line. As I have noted previously, Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) has been hoarding enormous amounts of cash (upwards of $120 billion) as it does not see an efficient way of deploying it at this time.

Buffett has traditionally been an opponent of buying gold, pointing out that it is a non-productive asset, that it does not pay a dividend, does not compound wealth and so on. With interest rates as low as they are, however, the same can be said for cash. Moreover, unlike cash, gold does not lose value with inflation. And of course, it tends to go up in turbulent environments when stocks are going down - precisely the kind of scenario that risk-conscious value investors are worried about. I believe that investors should seriously consider owning gold while they wait for valuations to come down.

Of course, this point of view presupposes that the market is actually overvalued. Why do I think this? Well for one thing, the overall price-earnings ratio is at historically high levels. I do not believe there has been some dramatic technological breakthrough in the last few years that would propel stocks to a "permanent plateau;" therefore, it seems more likely that things will revert to their historical mean.

If this bull surge has not been driven by stellar economic fundamentals, what has it been driven by? In a word: the Federal Reserve. According to economist David Rosenberg, over the last four months (when the Fed began its expansionary "not-quantitative easing" program), the correlation between the Fed’s balance sheet and the S&P 500 has expanded to 95%, displacing the correlation between gross domestic product and the index as an important driver of growth - this now stands at just 7%, whereas historically the correlation has been 30% to 70%. In other words, stock prices have become untethered from reality and are now being driven almost exclusively by the money-printing activities of the U.S. central bank.

It certainly seems like this is unsustainable. At some point, the Fed is going to have to turn off the spigot. At that point, the party will abruptly end. Of course, don’t expect central bankers to capitulate entirely. Rosenberg believes the next logical step for central banks will be to deploy "helicopter money" - direct monetary transfers to citizens and private lenders in an attempt to combat deflation and low growth. Of course, such policies would have a significant negative effect on the value of the American currency, which is why he believes that gold will be headed higher.

Personally, I do not believe gold should necessarily be counted on as a high-income play. It could be argued that its main function for value investors is that it is a stable store of value. Moreover, by investing in a gold exchange-traded fund, you still have the ability to quickly convert those funds into cash if a buying opportunity presents itself. In a world of sky-high valuations, you can’t ask for much better than that.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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