Playing the Long Game With Gold

Dan's obsession with shiny objects... Betting against the Fed... Understanding the 'Lindy effect'... Learn to play the long game with gold... How investors behave when they're worried...

Editor's note: While Digest editor Justin Brill enjoys his vacation, we're finishing up the week with Extreme Value's Dan Ferris and his thoughts on gold's recent performance.

In today's Digest, Dan shares his frustrations over an old adage about the Federal Reserve, the effects of its monetary policy, how the value of gold fits into the mix, and why investors should consider a long-term viewpoint.

I seem to be obsessed with shiny objects...

With your kind indulgence, I'd like to get some stuff off my chest today.

On Tuesday, I wrote about the $13 trillion of negative-yielding debt in the world.

Almost in passing, I mentioned that a "sane, rational, long-term investor" would naturally find himself buying gold when interest rates are zero or negative.

And yesterday, I called gold a "new song" investors ought to be singing these days.

It's funny to call gold a new song, though. Humans have been using it in one form or another for more than 5,000 years (6,000 if you count electrum, a naturally occurring gold/silver alloy used in ancient Egypt).

I doubt longtime Digest readers need to be reminded that other Stansberry editors have recommended various bets over the past year on gold.

Gold has rallied sharply since last week, when it traded for as little as $1,383 an ounce, according to data compiled by Bloomberg. Yesterday alone, it spiked to around $1,446 an ounce.

That's about a 4.5% move in a single week, a big jump, and a new six-year high for the metal.

It's no secret why many traders and investors have bid gold prices higher recently...

They're trying to front-run the Fed.

A lot of investors anticipate that the Federal Reserve will cut interest rates at the next Federal Open Market Committee meeting at the end of July.

The traditional belief is that Fed rate cuts push asset prices higher. Lower interest rates translate to higher bond prices. That makes bonds less attractive, and riskier assets relatively more attractive. Lower interest rates also make it cheaper to borrow money for anything whatsoever, from leveraged stock market investments to new cars and fancy vacations.

These days, higher asset prices on the back of Fed cuts are viewed as an iron law of finance. The old saying, "Don't fight the Fed," rings in the ears of many investors. (Too many, I'd say.)

By that logic, you're certifiably insane if you bet against Fed rate cuts driving asset prices higher. So when the Fed makes cuts, or even talks about cutting rates, folks buy. (I've done some buying lately, too, of put options on equity indexes. Insurance helps me sleep well at night.)

You buy bonds because low interest rates mean higher bond prices. You buy stocks because lower interest rates make stocks more attractive. Maybe you buy a bigger house than you might have at lower interest rates because you can get a lower mortgage payment.

It strikes me as profound that, whatever you're expected to do when falling interest rates are on the table, getting rid of dollars seems to be the No. 1 priority... another way this whole deal points to gold's strong performance.

I'm not really in the 'don't fight the Fed' camp...

I understand why others are there. But my obsession with gold is rooted in the exact opposite viewpoint. I'm betting against the Fed. You could say I'm fighting the Fed.

Let me explain.

Extended rounds of interest-rate cuts have generally correlated with recessions... and equity bear markets. Look at the last few U.S. recessions compared with the upper bound of the federal-funds rate targets established by the Federal Reserve. It's pretty clear that falling fed-funds rates have gone hand-in-hand with recessions.

You don't need a visual to know how poorly stocks perform during a recession. Just look at the above chart, and think about it. You probably remember those last two recessions and the corresponding bear markets quite well.

The upshot of this chart is that, when the Fed starts cutting rates, watch out. It means the Fed smells trouble.

It makes you wonder where in the world this whole "Don't fight the Fed" thing came from in the first place. It seems like the smart bet would be against monetary policy saving you and me from declining asset prices.

In fact, I'll go one step further: If you look at how rate cuts started right before the last few recessions, the proper adage for traders and investors seems to be, "Fade the Fed." Bet against its ability to do anything but make life more difficult for savers and investors.

So where does gold fit into this?

I'll show you right now.

Last year, at our annual Las Vegas conference (a wonderful shindig, which I highly recommend!), I presented the audience with a few charts that showed how gold prices (measured by the Philadelphia Gold and Silver Index) have behaved in the last few bear markets compared with the S&P 500 Index ("SPX")...

It's no great coincidence that gold holds up well when equity prices are in freefall and the Fed is pumping out liquidity to beat the band. It is and ought to be as regular as the seasons (given the existence of a Federal Reserve, at least).

One reason gold works so well is what trader/flâneur Nassim Taleb calls the 'Lindy effect'...

I alluded to this earlier when I said gold has been around for 5,000-6,000 years.

The Lindy effect – which for convoluted reasons takes its name from New York's famous Lindy's deli – says that for nonperishable items, every additional day of existence might imply a longer life expectancy.

Think of it this way: If a practice or product has been around for X number of years, it'll be around for another X years. For example, if a book has been published for 200 years, it's likely it'll be published 200 years from now.

I was relieved to discover the Lindy effect a few years ago (in Taleb's book, Antifragile). When I was a young music student in the 1980s, I worried that someday the world might lose the music of Beethoven or Bach. But Bach died 269 years ago, and Beethoven 192 years ago. We're still listening to them. So I don't worry anymore and fully expect that, if I lived for another 269 years, they'd be at least as popular as they are today. And with every day that passes, that's another day tacked onto their likely longevity.

Not everything Lindy is good. For example, the practice of bloodletting was around for 3,000 years. At the 1,500-year mark, you could have said bloodletting was Lindy, and you'd have been right. Fortunately, we moved past bloodletting, but it took another 1,500 years.

Gold doesn't treat you like vampire food, and its value has been recognized for 5,000 years. For good reason, too. By the Lindy effect, it'll be around – and used much the same way we use it today – for another 5,000 years or more for the same reason. It works.

In Taleb speak, simply put, gold is Lindy.

Putting it all together...

Stocks are way up after a 10-year bull market. Stocks are expensive (as I discussed on Tuesday). Global bonds are in an enormous bubble, with even some junk bonds trading at negative yields. The Fed's easing has often correlated with recessions and bear markets over the last several years.

As listeners to the Stansberry Investor Hour podcast know, I place a high value on negative definitions. It's a good idea to say what something is not when you're trying to figure out what it is.

So it's less accurate to say gold is a good bet here than to say I don't understand anyone not owning gold right now. I don't understand how you can look at stock and bond markets – and the insanity that is monetary policy – and come away without some shiny objects in your portfolio.

Am I predicting that the big run-up in price of the last week or so will continue into next week and the week after?

No.

Three technical traders I know have all expressed the belief that they suspect this gold rally could be a "head fake" going into the Federal Reserve meeting. They're short-term guys, so it doesn't worry me. If gold falls back into the $1,300s, nothing I've said here is off the table. I still think a bet on higher gold prices over the next few years – maybe longer – is a prudent one.

Today, I'm also thinking about how investors behave when they're worried...

Yesterday, we pointed out that our friend Jason Goepfert over at SentimenTrader said his "Dumb Money Confidence" indicator is above 80%, which he notes is a level that has preceded poor equity returns in the past.

When equity investors think they need protection, they buy put options. That makes the CBOE Volatility Index ("VIX") go up.

The VIX, often called "the market's fear gauge," is around 14 today.

Its average closing price going back to 1993 is 19, according to Bloomberg data. As you can see from the chart below, since 1995, the VIX has spent several years above current levels...

That makes recent volatility look quite tame. It's still scraping the bottom after crashing from its December 2008 high.

The low VIX implies investors aren't worried at all.

I watched a good interview on Real Vision this morning with a macro strategist named John Burbank. He recently called around to a bunch of big financial institutions to try to convince them to hedge against interest rates going to zero, which is how he is playing the possibility of trouble in the global equity market and other financial markets.

Bottom line: there was zero interest. Investors – individuals and professionals alike – have put their trust in the Fed. They think the Fed will save them, as it "saved the world" after the financial crisis. They're like Alfred E. Neuman, the goofy guy on the cover of Mad Magazine, famously saying, "What, me worry?"

Burbank said this attitude reminds him of the years before the financial crisis, when nobody in big financial institutions would even entertain the idea that housing prices could fall and mortgages could become very bad bets.

Similar to the VIX is the CBOE SKEW Index, which offers a 30-day look at the potential for a big stock market crash based on options prices. When the SKEW Index rises, it means investors are becoming more worried that the market is going to crash.

The SKEW hit its all-time high of 159 on August 13, 2018. A month later, the S&P 500 Index peaked... and then entered a three-month 19% rout. Chalk one up for the SKEW!

In January, the SKEW hit a five-year low around 111. It was at 112 a month ago... And it's around 125 today.

So maybe some smart folks are starting to get a little worried, but they're a long way from where they were last August – a level of fear that would make a lot more sense to me right now.

They're just not worried enough.

Maybe you think I'm too much of a worrywart.

I suspect if the Fed does cut rates later this month, and stocks and bonds rise as investors take the bait, you'll look back on this Digest and say, "Well, Dan, you got that one way wrong."

Not so fast.

Again, I'm looking out years... not weeks or months. This isn't a viewpoint that I'll abandon until enough time has gone by to prove it totally wrong. Fortunately, no matter what happens in the next few months or years, owning gold and being a value investor (like I mentioned yesterday) are good ideas over the long term.

Have a great weekend.

52-week highs (as of 7/18/19): First Majestic Silver (AG), Sprott Physical Gold and Silver Trust (CEF), VanEck Vectors JPMorgan Emerging Markets Local Currency Bond Fund (EMLC), Franco-Nevada (FNV), SPDR Gold Shares (GLD), Barrick Gold (GOLD), Hershey (HSY), Kirkland Lake Gold (KL), Lundin Gold (TSX: LUG), MAG Silver (MAG), McDonald's (MCD), Medtronic (MDT), MarketAxess (MKTX), Match Group (MTCH), NovaGold Resources (NG), Nestlé (NSRGY), NVR (NVR), Royal Gold (RGLD), ResMed (RMD), Sandstorm Gold (SAND), Starbucks (SBUX), Vanguard Inflation-Protected Securities Fund (VIPSX), and Wheaton Precious Metals (WPM).

Today's mailbag touches on a variety of topics... Feedback continues about Porter's most recent Friday Digest, a reader praises "cutting the cord," and one subscriber shares his thoughts on the "American Jubilee."

Do you have a question or comment for us? As always, send your e-mails to feedback@stansberryresearch.com.

"Just wanted to take a moment and say 'thank you' to Porter for his lengthy newsletter regarding real negative interest rates. I wanted to let you know that I did read it multiple times to make sure that I didn't miss anything. I, for one, believe I am getting a college education (not a degree, but an education) when I read Stansberry Research material. I am currently overweight on gold and silver since Porter's passionate plea, and my portfolio is glad that I did.

"Your team doesn't realize it, but you all help my investing decisions and emotions by 'talking' me through the market conditions and events with your insights each and every week.

"While I'm at it, I'd like to give a shout out to Dan Ferris for his work each week on the Stansberry Investor Hour. I had stopped listening when Porter and Buck stepped away because I thought it was going to be a lot of boring value talk (no offense, Dan). But Dan has consistently blown me away with his guest interviews and informative subject matter.

"On a final note, I recently listened to a podcast done several months ago with Jason Goepfert as the guest where Steve and Porter were debating where interest rates were headed. It was fun for me to listen to a past podcast knowing where we are in the economy now several months later.

"Just wanted to say 'thank you' to the entire team for all that you do to help us.

"Keep up the great work." – Paid-up subscriber David D.

"We cut the cable cord over five years ago. The $5,100 we have saved is sitting in our safe in the form of gold. Why waste your time on mind-numbing content that, even if you missed it, would not diminish your life one iota. Learn a foreign language, computer code, take a course in higher math or science. Your life is too short to spend it wasting away in front of the boob tube." – Paid-up Stansberry Alliance member Jose T.

"I'm approaching 60 years old and have worked hard my whole life to accumulate a portfolio of very nice properties that I'm developing or renting. It seems to me however that the capitalist system is coming off its rails. Debt the world over is increasing while the rich get richer and democratic values are under attack. I don't know why, a crisis of capitalism or bungling by governments and national banks, but I do believe the only solution is a debt jubilee. This is the only way that millennials and others would be able to get out from under the crippling debt that has been imposed on them, allow them to get on with their lives, raise families, buy houses and cars, with savings, not with debt.

"My only hope would be that any debt restructuring would be done in such a manner as to penalize most those who have most benefited from this corrupted capitalism. Some characterize FDR's confiscation of gold savings and subsequent devaluation of the U.S. dollar, during the Great Depression, as a form of theft. Maybe that's true. But perhaps FDR was a modern day Robin Hood, stealing ill-gotten gains from the rich and giving it to the deserving poor, who could then get on with their lives, buy houses and cars, make the economy great right into the 1960s. What we need, the world over, are leaders with Franklin Delano Roosevelt's vision to oversee this debt jubilee." – Paid-up subscriber David D.

Good investing,

Dan Ferris
Vancouver, Washington
July 19, 2019