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5.5% profit from BNP Paribas in our upside view

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BNP Paribas

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Gold as an Inflation Hedge: What the Past 50 Years Teaches Us

50 years ago on Aug. 15, 1971, to be exact then-President Nixon interrupted “Bonanza,” one of the most popular TV shows of that era, to announce that he was ending the convertibility of the U.S. dollar into gold. Many consider it to be one of the most consequential decisions he made. Up until this “closing of the gold window,” foreign central banks had been able to convert U.S. dollars into gold bullion at the fixed price of $35 an ounce. In theory, this had imposed a strict monetary discipline on the Federal Reserve, since inflating the money supply could have caused a run on Fort Knox, where the U.S. stored its supply of gold. And inflation did indeed jump in the years following Nixon’s decision to remove that restraint. So did the price of gold, which today is 50 times as high as it was that day.

This apparent correlation between gold and inflation has led many to believe that gold is a good inflation hedge. This belief isn’t supported by the data, however. If gold were a good and consistent hedge, the ratio of its price to the consumer-price index would have been relatively steady over the years. But that hasn’t been the case, as you can see from the accompanying chart: Over the past 50 years, the ratio has fluctuated from a low of 1.0 to a high of 8.4. Gold is only a good inflation hedge over time frames far longer than any of our investment horizons, according to research conducted by Duke University. Over shorter periods its real, or inflation-adjusted, price fluctuates no less than that of any other asset. Even though the price of gold is 50 times as high as in 1971, stocks have performed even better. The S&P 500 has produced an annualized return of 11.2% since August 1971, assuming dividends were reinvested along the way. That compares with 8.2% annualized for gold. 

Screenshot 6

Only reason gold came even this close to matching stocks over the past 50 years was its huge return during the first decade following Nixon’s announcement. Take away that decade, and gold has lagged behind even intermediate-term Treasury notes. Over the past 40 years, gold has risen at a 3.6% annualized rate, compared with 12.2% for the S&P 500 and 8.2% for the Treasurys. This doesn’t mean gold has no role to play in a diversified portfolio, however, even assuming the future will be like the past. Because the correlation of its returns with those of either equities or bonds has often been low or even negative, its presence in a portfolio can reduce volatility. Over the past 50 years, a stock-and-bond portfolio could have improved its risk-adjusted performance by adding a small allocation to gold—around 5% or so.

Still, even gold’s volatility-reducing potential isn’t guaranteed, since gold’s correlation with stocks has varied widely over the years. In fact, there have been occasions in which gold’s correlation to the stock market has been positive, which is just the opposite of what it should be to reduce a portfolio’s risk. One such recent occasion came during the stock market’s waterfall decline in February and March last year: Stocks of gold-mining shares dropped 39%, as measured by VanEck Vectors Gold Miners GDX -2.44% ETF (GDX)—even more than the 34% drop in the S&P 500.

The next 50 years

It is always possible that gold will be a more consistent inflation hedge in coming years. It’s just that you will have to look elsewhere than history to find support for such a possibility.

6.3% profit from Honeywell in our downside view

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Honeywell

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10.6% profit from Anglo-American PLC in our upside view

AANGLOexit

Anglo American

 

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6.4% profit from Coca Cola Inc in our downside view

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coca

 

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6.3% profit on Salesforce in our upside view

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Salesforce

 

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Don’t Believe the Inflated Yields on Inflation-Protected Bond Funds

Inflation heated up again this week, but it’s nowhere near as hot as funds specializing in bonds that fight it.

Mutual funds and exchange-traded funds that buy TIPS, or Treasury inflation-protected securities, are boasting yields of 8% or more in a bond market where even 4% looks outlandish. Such funds took in an estimated $36.3 billion in new money in the first half of 2021, according to Morningstar—a record for any six-month period since TIPS funds were born in the late 1990s.

If an 8% yield tempts you to join them, listen up. These funds that purport to fight inflation are, ironically, inflating their own reported yields. 

Screenshot 5

TIPS are notes and bonds, issued by the U.S. Treasury, whose value varies with changes in the monthly Consumer Price Index. When that measure of inflation rises, the principal value of each of these securities goes up; so does its interest payment. When inflation declines, the TIPS’ value and interest fall with it. TIPS pay interest, albeit not much these days—a 5-year note sold in April has a coupon of 0.125%. A big chunk of the return instead comes from the inflation adjustment to the principal.

Under rules from the Securities and Exchange Commission, funds take “dividends and interest” earned per share during the prior 30 days, deduct expenses and annualize it. The resulting SEC yield tends to be roughly what you’d get if you multiplied the previous month’s net income by 10 or 12.

The SEC’s rules for calculating its yield, however, don’t say whether to include the inflation adjustment or leave it out. And that gives fund companies a lot of leeway.

As the economy roared back, the Consumer Price Index came in at unusually high levels of 0.8% in May and 0.9% in June. Those are monthly numbers, so funds that annualize them and include the inflation adjustment to principal in their income have been reporting monster SEC yields. To believe in that yield is to imagine that such fluky numbers are sustainable.

Among the many examples , were the $9.7 billion Fidelity Inflation-Protected Bond Index Fund (SEC yield: 7.11%), the $12.4 billion Pimco Real Return Institutional Fund (8.2%) and the $29.2 billion iShares TIPS Bond ETF (8.4%).

 

 

7% profit from Ford Company in our upside view

 

Fordexit

Ford

 

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10.8% profit from Caterpillar in our downside view

 

Caterpillarexit

Caterpillar Inc All Sessions 20210702 16.44

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