Gold declined approximately 28% for the year of 2013, its worst annual performance since 1981 according to USA Today. At that time, the downturn ended Gold's own bull market run of 12 consecutive years as investors jumped on the back of this current bull market by piling into stock funds in 2013 and largely exiting bond funds.
Net New Cash Flow of Long-Term Funds (Millions of Dollars)
Type Year-to-Date (YTD) 2013
Stock Mutual Funds 158,843
Hybrid Mutual Funds 73,226
Taxable Bond Mutual Funds -9,473
Municipal Bond Mutual Funds -48,449
Money Market Funds -28,723
Source: Investment Company Institute, Trends in Mutual Fund Investing, November 2013.
As a result, many investors chose to remove allocations to Gold in their portfolios, seeing no significant upside potential or inflationary pressures in the near-term horizon. These investors may be regretting their decision thus far in 2014. As of the close of business on March 13, Gold has increased by 13.86% thus far in 2014 as measured through the popular SPDR Gold Shares ETF (NYSEARCA:GLD). As a point of reference, through the close of business on March 13, the S&P 500 has returned 0.28% while the DJIA has returned -2.28% YTD in 2014.
Performance of GLD (December 31, 2013 - March 13, 2014)
Source: 2014 YTD performance of GLD provided by Morningstar as of March 14, 2014. Past performance is not indicative of future results.
We believe that the reason for the strong performance of Gold out of the gates in the New Year can be attributed to both the recent volatility of the stock market and the perception of potential risk in the bond market (notably U.S. Treasuries) in an environment where interest rates are expected to rise. The enhanced accessibility to Gold exposure through the evolution of exchange-traded products (ETPs), in general, also adds to investors' attraction to the precious metal.
Volatility has returned to the stock market during the 1st quarter of 2014 due to several market impacting events including, but not limited to, budget and debt ceiling debates in Washington, geopolitical turmoil in Ukraine, emerging market currency fears, slowing growth in China, and overarching investor sentiment that perhaps this current bull market is nearing its end, recently having passed its 5 year mark. During these periods of heightened volatility, investors, in our opinion, are now looking to precious metals -- Gold in particular -- as a "safe haven" in the same way that investors used to seek out the safety of U.S. Treasuries when downside pressures increased in the equities market.
This wary view of Treasuries as a safe haven seems warranted as the Federal Reserve ("Fed") balance sheet is largely occupied by U.S. Treasuries and when the Fed does choose to start shrinking their balance sheet (i.e. selling these bonds) - which we still contend will not likely begin until 2015 - the prices of these bonds will likely suffer declines. To put this fear into perspective, here are some characteristics of the Fed's current balance sheet, according to Forbes article by Robert Lenzer entitled, "I Bet You Didn't Know The Fed Owns 40% of All Treasuries Over 5 Years in Maturity":
- 36% of all U.S. Treasury securities between 5 years and 10 years in maturity reside on the Fed balance sheet
- 40% of all U.S. Treasury securities over 10 years in maturity reside on the Fed balance sheet
- 75% of the Fed's $4 trillion balance sheet (i.e. $3 trillion) is comprised of U.S. Treasury securities
Hence, Gold, as a type of the alternative investment, provides another form of volatility dampening for investors.
While escalating investor concerns in the New Year about mounting inflationary pressures in the system given the continued stimulus being added to the U.S. economy by the Fed each month (which is steadily decreasing as a part of their Tapering process) may also be a factor contributing towards Gold's recent rise, we believe that this effect is relatively insignificant. A larger contributing factor is likely associated with investors' desire to find an alternative strategy for both safety and upside potential during periods of market volatility as previously discussed.
However, Gold is not the only precious metal to have outperformed the stock market, as measured by both the S&P 500 index (S&P 500) and Dow Jones Industrial Average (DJIA) thus far in 2014. Outside of Gold, other noteworthy precious metals include Silver, Platinum and Palladium. Silver is one precious metal that may be even more attractive to investors as it has more industrial uses at present when compared to Gold. According to Bloomberg, as of March 14, 2014, the spot prices of these three metals have increased 9.78%, 7.24% and 7.90% respectively.
Aside from just investing in precious metals, we believe that investors should continue to consider adding a wide range of asset classes, in an effort to find pockets of attractive risk-adjusted return opportunities, to their respective portfolio management processes given our forecasted increase in market volatility over the course of the first quarter of 2014 (at least). With this said, we do also believe at this time that stabilizing, underlying economic fundamentals, and the activist nature of the Federal Reserve, will prevent any pullback that may take place in the stock market as a result of a significant pick-up in volatility from escalating into a more serious market downturn or correction.
Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program consistent with the investment theme discussed in this article. This article is for educational purposes only and should not be considered as a solicitation to purchase or sell any of the securities mentioned. As a reminder, past performance is not an indication of future results.