- It might sound crazy, but gold at $20,000 is a highly probable scenario.
- However, gold at $600 is also a probable scenario in the short term.
- I’ll discuss how to position your portfolio to take advantage of scenario 1 and not lose much in scenario 2.
I’ve already written about how gold should be an essential, but small part of each portfolio. My theory is that by putting a few percentages of your portfolio into gold miners, you hedge yourself against anything that might happen while you don’t risk much as all you can lose are those few percentage points.
In the next recession, let’s say the FED goes into negative interest rate territory alongside new quantitative easing rounds and the S&P 500 drops 50% or more. In such an economic and market scenario, I wouldn’t be surprised to see gold at $2,500 or above per ounce. Many gold miners would see their profits explode and stock prices increase at least 10 times. Therefore, a small 5% portfolio allocation to gold miners will probably protect you from a 50% drop in the S&P 500 as the 5% gold portfolio would replace the loss.
Now, you’re probably asking yourself, if gold mining stocks can go up 10 times while the S&P 500 can drop 50%, why don’t I invest everything into gold miners? Well, it isn’t that simple, nobody knows what the future will look like and especially when something will happen. Therefore, it’s essential to think in scenarios and prepare your portfolio accordingly for the maximum return at the lowest risk.
Let’s look at the two most probable scenarios for gold.
The Bullish Case – Gold At $20,000
Now, when somebody says gold will be at $20,000, most would assume that that person is just another crazy pundit. However, the idea isn’t so crazy. If we take a look at past gold price movements, it’s clear that the current gold price of $1,338 would have also seemed to be completely crazy in 1999.
Figure 1: Gold prices in the last 50 years. Source: FRED.
From 1968 to 1980, gold prices increased more than 15-fold. Similarly, from 2000 to 2012, gold prices increased 7-fold. In the 1970s, gold prices were rising due to high inflation levels while in the 2000s, the reasons were declining interest rates, quantitative easing, and financial turmoil.
Now imagine what’s going to happen when the next recession hits the U.S. and other developed economies. Every economy works in cycles, but most market participants seem to have forgotten about cyclicality and continue to happily push the S&P 500 to new highs.
We already know that the FED, ECB, and BOJ are going to do whatever it takes to provide liquidity to the system just as they have been doing for the past 10 years to postpone any kind or economic downturn. Nevertheless, such behavior will only exacerbate the next crisis because at some point, people will lose faith in money and central banks. When that happens, we will have inflation coming from new quantitative easing programs and low interest rates, financial turmoil coming from negative earnings and defaults, perhaps some political unrest, and I wouldn’t be surprised to see gold increase 15-fold, just as it did in the 1970s. Multiplying the current price of gold ($1,338) by 15, I get a value of $20,070 per ounce.
Now, I’m quite convinced we will see gold at $20,000 at some point in the future because the debt burdens developed countries have will require high inflation to be settled as economic growth continues to be slow and there is no sign of faster economic growth. However, I only have a small part of my portfolio invested in gold miners because I don’t know when the above scenario will play out. If gold prices fall to $800 or even $600, I need to leave some space to rebalance and that’s impossible to do if I have 50% of my portfolio in gold miners.
Let’s now discuss the second scenario, one where gold falls back below $1,000.
Gold Below $1,000
If the global economy and especially developed markets continue to grow at current rates for a longer period of time, central banks manage to increase interest rates, trim their balance sheets, and inflation remains under control, I wouldn’t be surprised to see gold prices below $1,000, at least in the short term. If gold prices go below $1,000, many gold miners will become unprofitable and perhaps even go bankrupt.
Figure 2: Gold miners’ cost curve – below $1,000, most of them would be in trouble. Source: Goldcorp.
As gold prices depend mostly on sentiment and not on supply and demand, we can’t call $1,000 per ounce—which would make 90% of gold miners unprofitable—a bottom price for gold. Therefore, we have to leave the downside open and this has imminent implications for our portfolio allocation.
If gold goes to $20,000 in the next decade, then any kind of gold related investment would be a jack-pot. But we don’t know how long it will take for gold to reach such a level and whether it will fall to $600 before it goes to $20,000. Therefore, you really have to think about what kind of portfolio exposure to allocate to gold.
The easiest thing to do is to take a fixed percentage and then rebalance accordingly until something important happens, like a recession, when you could think about letting your gold gains run.
By allocating 5% of your portfolio to gold investments, you protect yourself from future potential financial turmoil coming from the unprecedented monetary easing policies and low interest rates combined with slow economic growth. If you can stomach volatility, I would definitely go for gold miners but if you prefer more stability, then actual gold would also do the trick of protecting your portfolio where you limit your downside but the upside is also trimmed. In order to allow for liquidity and make rebalancing easy, a Gold ETF doesn’t seem like such a bad idea.
So, gold and gold miners are an investment where you can lose even 90% of your investment but also make 10, 20, or even 50 times more than what you invested, plus you are hedged against economic turmoil and loose monetary policies. Not such a bad risk reward investment, now is it?