Gold Is A Natural Hedge Against Bad Fed Policy

Gold doesn’t get any respect for its core attribute.  Some investors think of gold as an inflation hedge because it has maintained its purchasing power over time.  Others seem to think that gold is some type of hedge against a stock market crash.   Yet gold doesn’t correlate with the stock market and it doesn’t move in lockstep with the Consumer Price Index.  It is a hedge against the federal government making bad fiscal policy.  While inflation does come about because of bad policy, it isn’t a cause-and-effect relationship with the world’s favorite shiny metal.  Gold is the ultimate hedge on the government screwing up, and they have been screwing up quite a bit this new century. 

Since 2000 gold has handily beat stocks appreciating over 500% while the total returns of the S&P 500 are a bit north of 190%.  There is no question that this is the result of the federal government spending like a drunken sailor.  After the crash in 2008, the Federal Reserve decided it would be better to bail out the economy at the cost of the solvency of the US government.  The credit rating agencies realized that they had to downgrade US government debt.    

Twenty years ago the Federal Reserve had a 6.5% interest rate target and inflation was in check.  Not only was there no government deficit but the dollar was strong.  This was all before the world caught the virus.  Of course, I don’t mean COVID but rather the dangerous idea that we can just print however much money we want and spend it.  Since then the M2 money supply has increased from 4.6 trillion to over 20.3 trillion. 

Fast forward to where we are today and they are pretty clearly playing monetary policy fast and loose. Interest rates are as close as they could be to zero and real returns are quite negative accounting for a 5% increase in consumer prices over the last year.  Not only has the Federal Reserve purchased a wide array of government bonds and mortgage bonds but they have also taken the place of private lenders buying into the corporate bond market via ETFs.  The idea of fiscal discipline has been replaced with Modern Monetary Theory running a budget deficit north of a trillion.

While the problem for investors that are looking to hedge their portfolio against the bad policy is clear, the solution is less obvious.  Many investors resort to gold ETFs that don’t generate any earnings or pay a yield like iShares Gold Trust IAU or SPDR Gold Trust GLD.  Another alternative is the Solactive Gold Backed Bond Index which has been a great solution for investors that need a fiscal policy hedge from gold and income from bonds.  The index generates a consistent yield from a portfolio of investment-grade corporate bonds of approximately 2.5% then hedges that portfolio against inflation with gold.  Since the portfolio has a full 100% exposure to gold it generated a historical return pre-inception on January 3, 2006, through today of 14.57% annualized.  This combination of a gold hedge and bonds has beaten the total returns of both gold all by itself and bonds.  The Strategy Shares Gold Hedged Bond ETF GLDB is designed to track the returns of the Solactive Gold Backed Bond Index and distributes a monthly yield.  The other alternative that is available to some Indian investors is Sovereign Gold Bonds that are denominated in grams of gold and pay a yield of approximately 2.5% as well. Yet, US-domiciled corporate bonds seem like a safer bet than Indian government bonds for a comparable yield.