Making Hay Monday
A tortoise, a hare & a relic
“The Fed is an agent of distortion. They have their fingers, their thumbs, on the scales of finance. To change the metaphor, we all live to a degree in a hall of mirrors.” -Jim Grant
“Learn from yesterday, live for today, hope for tomorrow. The important thing is not to stop questioning.” -Albert Einstein
Let’s Get Real About Returns
Like the children in Garrison Keillor’s Lake Wobegon, all Haymaker readers are above average. However, there are some who are even more impressive than the rest.
One of those exceptional subscribers emailed Team Haymaker this week challenging the Daily we ran last Wednesday showing that in gold terms the NASDAQ has had a negative return this millennium/century. (The same is true of the S&P 500, actually).
It wasn’t that he disagreed with our contention that gold has outperformed even the mighty U.S. stock market over the last 25-plus years; rather, he was questioning the validity of using gold as the measuring stick. It’s a good point and I thought you all might find my reactions to his comments of interest. (This reader’s unusual acumen was on full display when he wrote at the end of his email: “Thanks for all your great work and for one of my favorite books Bubble 3.0.” For those of you who aren’t aware, that’s a book I wrote back in 2021 and was published in early 2022. Of course, I’m kidding about this… maybe.)
His exact quote in this regard was: “No one, with the possible exception of gold bugs, measures stock returns versus gold.”
Again, point well made. However, I would argue that there is a growing number of goldbugs these days, including the elderly Haymaker.
What’s odd about my conversion to this once-fringe camp was that from 1981 through the first half of 2020 — so, basically, for 40 years — I was a “bond bug”. Personally, I preferred the moniker “bond bull” but, regardless, I built my career on inflation staying contained, thereby providing a real return on fixed income investments.
Before I get to the big-picture considerations, he also said his sources showed gold up “only” by a factor of 10. However, our data, including from Bloomberg, showed it rising from $288 at the end of 1999 to $3,400 which is close to the number of a 12-fold increase we used. However, that is about a 10.2% return versus the 10.9% we used. My apologies for this overstatement. Undoubtedly, it was my error. (Bloomberg didn’t like my attempt to run a Total Return Analysis on gold; again, almost certainly that was operator error on my part.)
Regardless, gold has substantially outperformed the NASDAQ for this century. Thus, one could make the argument relative to “real money”, “The Naz” has lost value.
As far as the accuracy of using gold as the yardstick, I would quote J.P. Morgan, the man who, long ago, said gold was the only true money and everything else was credit. When money and gold were interchangeable — i.e., when the U.S. was on the gold standard — this was a distinction without a difference. Richard Nixon famously severed that link back in 1971. This reader astutely made that point but he also asserted gold has lagged the S&P since then and might not ever catch up.
However, even this bright chap made a slight calculation error. The yellow metal is up by a factor of 100 over the last 54 years, using the gold price of $35/ounce which was its fixed price before the market began anticipating Nixon’s move (right before the gold link was cut, it had moved up to $41/ounce). The S&P is up by roughly 67 times.
However, there is the VERY significant consideration of dividends. Of course, gold generates no cash flow and that’s a massive disadvantage over a half century of compounding. Bloomberg shows that with dividends reinvested at the index return, the total return would be 11.16%. (One could quibble with how many investors actually reinvested into the S&P, but Iet’s use the higher number.)
Price appreciation and total returns on the S&P since 1971 (the higher return assumes dividends were reinvested into the index) - (Click to enlarge)
Google Gemini tells me that an asset which increases from $35 to $3,500 (allow me a bit of license to round up gold’s current price for simplicity), that’s a return of 8.9%. Yet, Gemini has both the S&P and gold at around a 7.6% total return. That seems low to me for both.
Let’s say gold has returned 9% and we’ll use that 11% number for the S&P. That means stocks have had an excess return of just 2% relative to “real money”. U.S. equities certainly have served as an inflation hedge but not the type of outstanding real returns most investors believe have been produced by stocks in the very long run.
Interestingly, going back another century before Nixon’s debasement, to 1872, the total return on U.S. equities, including dividends, has been just a tad below 9%. In other words, this was essentially in line with gold since it was untethered from the U.S. dollar.
However, another intriguing element is that gold had basically a zero return from 1872 to 1971, other than a one-time spike in 1934 when another U.S. president, Franklin Roosevelt, also devalued the greenback vs bullion. This moved it from $20, where it had been trading since 1870, to $35. Regardless, a return of 75% over 62 years was a negligible gain, like less than 1% annually.
After FDR’s dollar devaluation, gold then stayed at $35 for the next 37 years. Therefore, the return for holding gold for a century was close to zero. Yet, stocks generated their average 9% annual return from 1872 to 1971, albeit with tremendous volatility. Consequently, stocks absolutely crushed gold until 1971. After that, as we’ve seen, it’s been quite the horse race.
At times, like from 1971 to 1980, gold returned the favor, as it produced a staggering 33% average annual gain during the Disco Decade while stocks generated a mere 5.9%, including dividends. The S&P’s annual total return was below the average inflation rate in the ’70s of approximately 8% per year. But then, from 1980 to 2000, stocks once again smeared gold. Then, in this century thus far, gold is back in the lead.
The delinking of the USD to gold in 1971 obviously was a game changer. Moreover, per last Friday’s Guest Haymaker by the brainiacs at GoRozen, the inflation picture changed dramatically in the 1970s. In addition to taking the U.S. off the gold standard, Richard Nixon also pressured the Fed chairman at the time, Arthur Burns, to force interest rates lower. Mr. Nixon was following in the footsteps of what Lyndon Johnson had done in the mid-1960s to Mr. Burns’ predecessor, Bill Martin.
As a result of this presidential pressure, it’s no wonder inflation and the economy both ran hot into the mid-1970s before stagflation emerged. (Clearly, this is an ominous outcome based on what the Trump administration is attempting these days.) Without gold as an anchor, it took extremely high real, or after-inflation, interest rates under Paul Volcker to bring the CPI down from 12% to 4% and, eventually, to 2%. It was Mr. Volcker’s brave actions, by the way, that turned me into a “bond bug” back in the early 1980s. At one point, U.S. Treasurys were yielding almost 10% over inflation.
Mr. Volcker’s victory over high inflation was a major catalyst of the great equity bull market that ran from 1982 until early 2000, only briefly interrupted by the 1987 crash. (By late 1989, the S&P had fully recovered from that plunge. As a critical footnote, it was Alan Greenspan’s immense liquidity infusions in late 1987 – he’d replaced Paul Volcker earlier that year – that gave birth to what became known as the Fed put.)
This leads me to another key point I’m trying to make: when the Fed is maintaining high to moderate real interest rates, stocks generally outperform gold. However, since the start of 2000 and, particularly, from 2009 onward, the Fed has been mostly engaged in ultra-easy monetary policies. Until 2022, when the Fed was forced to raise rates in response to the highest inflation since the early 1980s, interest rates had mostly gone missing.
For sure, stocks have done very well since 2009, dramatically beating gold, despite that bullion has more than tripled over the last 16 years. The S&P, by comparison, has generated a total return of over 600%.
Yet, please realize this reflects U.S. stocks vaulting from seriously undervalued in 2009, during the depths of the Global Financial Crisis, to what is now among the most overvalued levels ever seen. This overvaluation is even more extreme on the high-momentum names that have been leading what I believe is a blow-off top. Once again, I’m indebted to Jesse Felder for this visual which I believe should send chills up and down the spine of any perma-bulls out there (actually, is there anyone who isn’t these days?)
In the next bear market, whenever that occurs, gold is likely to hold up far better than U.S. stocks. If so, its return advantage over equities will expand, perhaps dramatically. Yet, it’s improbable the Trump administration will allow stocks to go into a deep and lasting down-phase without pulling out all the stops to prevent the kind of protracted bear market seen from 1966 to 1982 and 2000 to 2012. This may even involve the Fed buying stocks using its digital printing press.
It is in large part due to my intense concerns about the direction of America’s fiscal and monetary policies that I believe gold and other hard assets — some of which I like better than bullion presently — are essential net worth protection vehicles. Looping back to the notion that only goldbugs measure stocks relative to gold, realize that in nominal terms emerging countries with high- to hyper-inflation have been by far the best performers over the last 20 years. Those include Venezuela, Zimbabwe, and, to a lesser degree, Turkey. Yet, in gold terms, those markets have produced negative returns. In Turkey, for example, the price of gold has risen by more than 1100% over the last five years, considerably greater than the 835% total return on its stock market. (The Turkish stats are per Google Gemini.) Therefore, in my view, deflating stock prices by gold is crucial to get a real (pun intended) sense of how well shares are protecting purchasing power and true wealth.
It is also vital to look at inflation-adjusted stock returns in those countries and, in fact, in any nation. The U.S. has been a much healthier story in that regard but it does raise the question of how accurately inflation has been calculated. Based on Team Trump’s mounting attempts to control the data narrative, I fear that government-issued inflation numbers will become increasingly distorted.
Yet, even now, based on Shadow Stat’s methodology, which uses the CPI tabulation process from the Volcker era, real returns on stocks have been much lower than popularly believed. In fact, a quick perusal of the blue line on the following chart would indicate S&P returns have been negative when taking inflation into account over the last quarter-century. This would also mean gold has done very little in real terms since the end of 1999.
It's a widely accepted reality that in an inflationary environment, asset prices can be pumped up by what is known as the money illusion. Using inflation as the benchmark to back this out relies on the accuracy of government statisticians. For most of the last 40 years, I haven’t had a problem with that, but my confidence level has fallen meaningfully since Covid.
Therefore, the oldest form of money – that would, of course, be gold – strikes me as a superior way to determine how stocks have truly performed. In fact, over the rest of this decade I strongly suspect the “barbarous relic”, as it was once pejoratively known, will widen its lead over U.S. shares, quite possibly dramatically.
It's been a long time since I provided readers with an in-depth take on one of my favorite ways to generate inflation-hedged income. Per the preceding macro/big picture section of today’s Making Hay Monday, the inflation protection aspect is likely to become increasingly important.