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All That Glitters Is Gold (and Silver)

By Jerry Beyke, CFA®August 20, 2020Economy, Investing

The Case for Real Assets in Our Multi-Asset Portfolios

For investors who are nearing retirement, or already in retirement, there is a greater need to have a balanced portfolio that includes other assets besides stocks. There were two periods over the last 20 years in which the stock market declined by 50% from its peak. The risk of that kind of drawdown in stocks is why we believe older investors, in particular, need to consider some “safe haven” assets to provide a buffer against the inherent higher volatility associated with stock market investments.

Traditionally, a standard asset allocation strategy for balanced portfolios would normally allocate 60% in stocks while investing the other 40% in high-quality bonds. Today, however, there are complications with trying to implement that traditional asset allocation plan. The yields now being offered on U.S. government bonds are so low that investors who buy Treasury bonds today are almost certainly going to earn a return from their bond portfolios that will be well below the expected rate of annual inflation.

The current coupon rate on a 10-year Treasury bond is just 0.6%, at the same time that the Federal Reserve is hoping to achieve a target annual rate of inflation of about 2% per year. If inflation does indeed average 2% a year over the next decade, and you only make 0.6% a year in income, that means that you will actually have a return of -1.4% a year in real inflation-adjusted terms.

When Treasury bonds are priced to deliver a negative inflation-adjusted return, as they are today, investors will no longer consider Treasury bonds to be an attractive place to invest the “safe haven” portion of their portfolios. With bonds being less attractive in today’s environment, we believe there is a greater demand for precious metals, such as gold or silver, as a potentially better alternative to Treasury bonds.

Like bonds, gold can be an effective hedge because it often increases in value when the stock portion of your portfolio is experiencing stress. Since 1972, there were 14 calendar years in which the S&P 500 Index declined. During that period, gold outperformed the S&P in 12 out of those 14 years in which stocks declined. We believe precious metals can act as a counter-cyclical buffer when stocks fall.

The Federal Reserve intends to keep short-term money market interest rates at 0% for at least the next two or three years. Meanwhile, the Federal Reserve recently bought $3 trillion of a variety of Treasury, municipal, and corporate bonds, using money that was printed out of thin air, using a tactic known as Quantitative Easing (QE). Because of the effects of the coronavirus pandemic on the U.S. economy, the Federal Reserve is deploying extremely stimulative monetary policies as an emergency tool to stabilize the U.S. economy and financial system. The concern many investors have is that the financial markets and economy have become overly dependent on extremely easy monetary policies. The Federal Reserve first started using these monetary policies during the Global Financial Crisis of 2008, and they were intended to be a temporary and emergency policy. The problem was the Federal Reserve was never able to normalize monetary policy and, more than a decade later, a whole new crisis has arrived with the coronavirus pandemic that led the Fed to revisit the same “money for nothing” policies. Is QE now an everyday normal?

We expect that the U.S. dollar may decline over the next couple of years, another factor that supports owning precious metals today. U.S. budget deficits are currently running at a far higher than normal level relative to our GDP. At the same time, the Federal Reserve is printing money at a rapid pace to help provide stimulus to our economy and financial markets. Under today’s unusual circumstances, we believe gold and silver can play a meaningful hedging alternative for our clients. As such, we currently target an allocation of 5-10% in precious metals in our Multi-Asset client portfolios.

If you have any questions or would like to learn more about the role of real assets and precious metals in your portfolio, please contact your Relationship Manager.

All material of opinion reflects the judgement of the Adviser at this time and is subject to change. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services.

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