Amid recent exchanges between Trump and North Korea, many Americans feel that they’re on uncertain ground. Moreover, the stability of that ground becomes more tenuous with each passing day as the rhetoric climbs. Escalating remarks are prompting investors to question assumptions about their long-term investments. Can history offer any clues to understanding how gold performs during war?

Though today’s threats of war involve the U.S. we can infer wartime price movements based on other international conflicts. Why? Because gold is an international currency and therefore responds to major upheavals across the globe.

A volatile period in the late 1970s brought many serious conflicts. In 1978, we saw the Iranian Revolution. Then, 1979 brought the Soviet Union’s invasion of Afghanistan and the Iran-Iraq war. During this same period gold rose 23% in 1977, then 37% in 1978. However, the real ascent came at the end of the 70s when gold shot up 123%.

Fast forward to 1990. Iraq invades Kuwait, the Gulf War starts and gold increases. Though as the conflict drew to a close gold returned to its pre-war levels. This pattern resurfaced shortly after the September 11th, 2001 terrorist attacks when gold increased again.

Interestingly, history shows that perceptions of war are as influential to gold prices as war itself. That is, when investors believe that a war will be short-lived gold responds with a downward movement despite lack of a peace agreement. This is intuitive as many people view gold as a safe haven asset which serves to preserve wealth in times of geopolitical conflict. For example some analysts have noted that as rumors of war grew amid U.S.-Iran tensions in November of 2007 gold surged to a then 27-year high.

Interestingly, gold can become a weapon, of sorts, during war. In 2012 Syria was forced to sell a portion of their 25.8-ton gold cache to buoy their efforts in the wake of heavy sanctions from Western and Arab nations. Occurrences like this are hardly isolated. Prolonged periods of war can hasten the evolution world finances as was the case when England and France dueled for nearly three decades spanning 1688 and 1756.

Chris Blackhurst, writing for The Independent explains “this led to the Financial Revolution, and the creation of The Bank of England in 1694.” The intention behind the bank was to raise desperately needed money for the government. In his review of Kwai Kwarteng’s book War and Gold: A Five-Hundred-Year History of Empires, Adventures and Debt, he explains “So began a curiously symbiotic relationship – of war and finance, both needing each other. Always, in uncertain times, there was gold itself to fall back upon. To the current period, and there are those who will maintain that our policy in the Middle East resembles those conquistadors.”

In uncertain times investors are wise to revisit their diversification plans. The road ahead is uncertain. Rather than attempt to predict outcomes it’s important to ensure that one’s portfolio is positioned for all eventualities.

The diversification game used to be a whole lot easier. Investors only had to choose a few stocks. Exposure to a few sectors across a dozen holdings was enough to be properly diversified. Today, the picture is different. The world is smaller.

Thomas Friedman, author of The World is Flat illustrated this phenomenon explaining, “In Globalization 1.0, which began around 1492, the world went from size large to size medium. In Globalization 2.0, the era that introduced us to multinational companies, it went from size medium to size small. And then around 2000 came Globalization 3.0, in which the world went from being small to tiny.” This concept is the reason diversification is becoming more difficult to achieve. As the world shrinks the interconnectedness of our industries increases. What impacts one, impacts another.

Many of the largest corporations in the U.S. have turned to emerging markets abroad for growth opportunities. This is a symbiotic relationship as these emerging markets depend on U.S. demand in their manufacturing arena. Data from Charles Schwab shows that equity correlations have been rising since 1995. This trend has prompted savvy investors to abandon the long-held notion that stocks, bonds and cash are the only tools available to the diversified investor.

Today, investors are learning that they can become diversified by expanding into international holdings, real estate and commodities like gold. The same body of research from Schwab explains that “commodities tend to perform differently in various market conditions than stocks and bonds – making them desirable from a diversification perspective.” This diversification, not seen with a traditional stock/bond portfolio, is critical in certain situations. For example, between 1973 and 2013 “commodity returns increased as inflation increased.” This dynamic is not true for stocks.

Detractors may cite that gold is a more volatile asset. However, it’s important for investors to consider this characteristic in relative terms. That is, gold, should represent one piece of a larger portfolio strategy that includes a variety of assets. The concept of viewing the risk profile of an investment (e.g. gold) within the broader context of a complete portfolio is the underpinning to Modern Portfolio Theory. The ideas behind this theory were first explored in 1952 when Harry Markowitz published his seminal work. He argued that the key to making this approach work is selecting a group of investments that, in aggregate, represent less risk than any of the assets alone. The key: the risks of these different holdings cannot be related.

As outlined earlier, culling a group of investments that have differentiated risks is more challenging than ever thereby putting the tenets of MPT further out of reach. Gold helps investors get closer to true diversification in the midst of our narrowing world. Why? Because there’s only about 183,000 tons of gold above ground. That total is unlikely to increase as mining operations are forced to work harder and spend more to extract the increasingly scarce resource. Corporate boards cannot simply issue more shares or split the stock.

Give consideration to what amount of gold is the right proportion for your portfolio.

Amid the fervor of a surging stock market there remains a less discussed data point lurking. The U.S. dollar has dropped 9% year to date against an index of other currencies. Some have attributed this slide to an early April comment from President Trump who lamented that “our dollar is getting too strong.” Eventually, he concluded, “that will hurt ultimately.” Meanwhile, it’s also likely that the gradual interest rate hikes we’ve seen have contributed to the decline.

Interestingly, some have posited that this definitive fall in value portends a brighter future for gold. In examining this phenomenon, one can turn to a 10-year comparison chart of The London Bullion Market (LBMA) fix gold price in relation to the daily closing price for the broad trade-weighted U.S. dollar index. The long-term picture reveals a clear inverse relationship.

For example, in mid-May of 2008 the dollar had sunk to one of its lowest points in recent history. At the same time gold was on a strong ascent choosing to rise as the dollar fell. Less than one year later the dollar began to make a sharp recovery while gold descended. Through the entirety of the 10-year span the relationship follows this “X” pattern where a rise in one asset begets a fall in another.

It’s important to note that this relationship, like nearly all in finance, is not a law of physics. There are periods when the two move in the same direction. In fact, Citi Research has gone as far as to state, unequivocally that “Commodity prices have traded in a strong inverse relationship with the U.S. dollar over the past decade or so, but this relationship broke down in late 2016 and the breakdown looks here to stay.”

Some may argue that data from just 2016 onward is insufficient to reach a conclusion that contradicts a decade of patterns. The main underpinning to their argument is that a reduction in volatility in the commodities market as well as a broad recovery from the global financial crisis has brought the negative relationship to an end.

Today we’re witnessing the dollar close at values nearing a 13-month low and investors are beginning to turn their attention, once again, to gold. Those asking how this trend will play out are looking to political headlines for clues. Economic policies designed to spur growth have not yet materialized amid a new administration. “”There seems to be very little progress being made on a number of ‘pro-growth’ Trump initiatives, all being net bullish for gold,” remarked an analyst with INTL FCStone.

In the meantime, investors are leaning on comments from the Fed for clues on gold’s direction. While additional rate increases are certainly possible it’s also likely that such expectations have already been priced into the market. Some analysts have remarked to The Financial Times that they hold a near-term target at $1,300 per ounce after weighing all the conditions.

Today, the correlation between commodities like gold and the dollar continue to evolve. However, for the long-term investor this holds little sway. The gradual, but significant rise in gold over an extended period always offers value.   

Investors piled back into the gold market last week, propelling the yellow metal to its highest level in six weeks. Increased worries about slower-than-expected economic growth helped boost precious metals prices.

Gold climbed as high as $1,271.50 an ounce, while silver hit $16.84 an ounce.

Precious metals got a boost last week after the Labor department announced slightly weaker-than-expected second quarter gross domestic product growth at 2.6%, compared to Moody’s forecast of a 3.00% growth rate. The “animal spirits” have yet to emerge to propel the economy forward to the 3% range. The slower growth could delay future Fed rate hikes, which is a gold-bullish factor.

The stalled legislative agenda in Washington D.C. also increased gold’s appeal last week after Republicans failed to repeal the Obama Care health law. The inability of the Republicans to push through health care legislation is reducing optimism that significant tax reduction or infrastructure spending will occur to stimulate economic growth.

All Eyes on Jobs Report
This Friday’s release at 8:30 am ET of the July employment report will be the next key economic report for investors. The median estimate for July non-farm payrolls is a 183,000 increase, which could add downward pressure to the overall unemployment number. “Another strong month of employment growth should have been enough to push the unemployment rate back down to 4.3% in July, and the surveys suggest it will fall even lower,” according to Capital Economics.

The labor market remains tight. For any businesses who have been trying to fill open positions, the tight labor conditions have made hiring qualified workers a challenge.

Investing Tactics

If the jobs data were to come out weaker-than-expected it would likely provide a lift to the gold market. Conversely, stronger-than-expected data would likely pressure the market.

If you are looking to add to your precious metals holdings, using any “dips” or short-term pullbacks in price is a smart way to build your position at more favorable prices. You can monitor current prices here.

Storm Brewing?

Gazing into the crystal ball, there could be a storm brewing on the horizon. With a stalled legislative process seen in Washington, what could this mean for the debt ceiling limit?

Treasury Secretary Steven Mnuchin has said that the government probably has enough available cash to meet obligations through September. The latest projections from the CBO suggest the debt ceiling limit will be hit in October.

“That  means  the  mid-September  FOMC  meeting  could  come  amidst  a  disruptive  fight  in Congress over raising the debt ceiling. Markets have already begun to price in some risk of default, with the yield on three month Treasury bills recently rising above that on six month bills,” Capital Economics said.

Noteworthy: markets are taking notice earlier this time. “Investors have started worrying about a debt ceiling stand-off much earlier than during previous crises.  Back in 2012 and 2013, markets showed little sign of panic until a week or two before the debt ceiling deadline, Capital Economics said.

If a stand-off in Congress rattles markets, gold will be a key beneficiary. It was the debt ceiling crisis in 2011 that sent gold to its all-time high above $1,900 an ounce.

Current levels offer a great buying opportunity for gold. In just a few months, headlines could be reading “Gold Hits 6-Month High.” Smart investors buy low and sell high. Current levels in gold are rising, but still remain relatively low. Call Blanchard today to discuss your investment plans.