Gold is not purely an inflation hedge, but more of a hedge against real interest rates, and rising bond yields that have outpaced the growth of inflation expectations has been weighing down on the precious metal, said Lyn Alden, founder of Lyn Alden Investment Research. “What gold really does is it protects you from an environment where inflation is much higher than the bond yields, and that’s what we’ve seen in 2020 is that gold over the past couple of years had a pretty big appreciation because it was protecting against that. Now, since about late summer 2020, negative real yields have been roughly flat,” Alden said.
Let's switch gears now, Lynn, and talk about the global economy. So the IMF has projected for the world economy to grow by five and a half percent this year and a further 4.2%. By 2022. So this takes us to slightly below pre COVID levels of output, but not quite until we get to 20, 22, and that will start to surpass pre COVID levels of output.
First of all, do you agree with this projection? Do you, do you see as continuing growth or are we going to shrink as some economists have suggested we might. Uh, so I think there's a lot of various around those estimates. And so, you know, economists just like a lot of us are guessing what's going to happen with consumer consumer behavior.
Uh, you know, hopefully in a, in a post virus world, uh, we're still kind of unsure about how much, uh, fiscal stimulus we're going to get in some of the different regions. And so there's a lot of those things that can change throughout the year that will affect those numbers. Overall, what we're seeing is that we should get pretty strong growth out of emerging markets.
At least at least some of the healthier ones. Uh, we should get pretty decent growth in the United States. Uh, Europe. The areas that's, uh, you know, uh, lagging pretty considerably, and that will parse this partially, you know, based on how they've constructed the Euro. Uh, so those countries have, you know, limited ability to do their own internal fiscal stimulus because, you know, they're not monetary sovereign.
Uh, and so that, that's kind of a challenge that, that Europe has to go through. Uh, but overall, I think, you know, we're, we're going to see strong growth in 2021, mainly just due to base effects, right. Because we're starting from. From such a beaten down level. Uh, but whether we not, we kind of reached new highs and in real GDP, I think remains an open question.
Uh, you know, I think by 2022, we would, uh, I'd agree with that assessment. But I think that, you know, I can see why some economists don't think we'll do it in 2021. Uh, and so, you know, because if you look. You know, in, in a broad sense, unemployment is still the tricky area, especially the United States. I mean, you know, we lost, uh, you know, millions of jobs.
And even though we've had a V-shaped recovery and asset prices, we've had a V-shaped recovery in certain indicators, jobs have, you know, done what I've, I've referred to as a back risk, square root sign recovery, where they had, uh, a quick VCA bounce, uh, after the immediate lockdowns ended. But then they started trailing sideways and that's where they look at, you know, the unemployment rate or.
Uh, you know, uh, you know, just the unemployment, the employment to population ratio, uh, all these different, uh, ways to measure how many people are in the workforce. And that's the part that's really struggling. And that's what can keep things down as is partially going to come down and what happened with fiscal stimulus.
And it's also, it's going to be important to watch what happens with the services sector, the restaurants, and the hospitality, uh, to see if there's a pent up demand for people to travel more and to go out to restaurants more because that's, that's the segment that's been more harmed. Yeah. So let's assume there is growth in our economy.
If you just take a look at the GDP and break it down by its components, which component do you think will grow the most? So if you took it, so if you consider, uh, government expenditures, government, uh, investments, um, consumer spending and net exports, which of these are likely to grow the fastest, do you think.
Uh, so I think government expenditures are going to be a very large component, uh, for a lot of the GDP calculations. Uh, because if you look for example, the United States, the, the amount of stimulus that they're expecting in 2021, uh, you know, earlier this, this, you know, it was the end of last calendar year, but as part of this fiscal year where they did that 900 billion, uh, you know, uh, you know, fiscal aid, uh, and then now they're currently working on a 1.9.
A trillion dollar package and potentially, uh, you know, if that goes through, uh, you're looking at, you know, maybe, uh, an infrastructure deal, uh, later this year, we'll see if they can get it through. I mean, they might not be able to, because there's, there's a very tight, uh, you know, kind of, uh, uh, political divided in, in, in Washington.
Uh, and so, you know, overall, I I'd expect government. Uh, to be a pretty big, uh, part of that GDP. I also think if you look at, you know, consumer spending the services side in particular might have a pretty sharp rebound. I know myself that if I could travel, I'd certainly like to, because I have that, that pent-up demand from, from not really traveling much.
And I think a lot of people are kind of in a similar boat. Uh, so that, that's kinda how I'm watching that. We've actually, you know, other areas have held a well, and we've already had strong retail spending and things like that. Uh, because people, you know, they, they couldn't do some type of activity, so they redirected that money elsewhere.
And so I think some of those places that have lagged are, are the place where we could see some growth. So how does this translate to investment implications? So government expenditures are likely to continue growing the services sector. Well, the services. Easy. You might just invest in some services related stock.
How do you, how do you invest in government expenditures growing? Uh, partially by, by investing in things that would do well in a more reflationary environment and so higher inflation numbers, uh, pinchy, higher bond yields. Uh, and so for example, you know, as we get later this spring, uh, we're gonna have, uh, you know, uh, attractive.
Base effects. Right? So if you look at, you know, cause, uh, you know, inflation took a dip back in March and April, uh, and then you're going to see somewhat higher inflation now. And it's, you know, year over year numbers are gonna be pretty significant because you're, you're going back to that, that depressed period of last year.
Uh, and basically as long as these large fiscal expenditures continue and there, you know, in large part being monetized by the. The banking system, uh, you know, that that's a direct increase to the broad money supply. And so I think at least nominally, uh, that, that pushes up a lot of prices of things. Uh, you know, we've seen it in asset prices and we're starting to get, you know, signs of, of inflationary pressures, especially in commodities in shipping costs, things like that.
And so I think that this can, this can continue throughout 2021. Uh, and so, you know, investing in, in, for example, things that benefited from a steeper yield curve, uh, which can include the banks. For example, I also, you know, I'm, I'm structurally bullish on commodities. Uh, and so we've, we've come pretty far, pretty fast as some of those, I wouldn't be surprised to see more volatility, but especially for some of like the low cost producers, the strong balance sheets, the ones that I think are gonna benefit from multi-year trend.
Uh, I still, I still think that's an attractive area. Speaking of inflation yields are starting to tick up, especially in the long end. So do you see a correlation there is that because of higher inflation expectations? Yeah, they're, they've been tracking inflation expectations pretty closely. And so that's actually one of the things that held gold down is that even though inflation, starting to tick up a little bit and especially inflation expectations, which look forward a little bit, uh, you know, the, the, uh, you know, bond yields on the long end of the curve have been taking up as well.
And so the negative, uh, the real yield of the ten-year treasury has, you know, kind of hovered around negative 1% rather than continuing to go down because that, that, that nominal yields keeping up with it. Uh, and so if this were to continue, uh, that actually presents, you know, in addition to, uh, you know, not being a good for bond holders because, uh, you know, there, even though it's, it's better for people buying into bonds.
Now it's bad for existing holders of bonds because a yield going up means the prices are going down. It also potentially puts some pressure on the mega cap. Growth stocks or even some of the smaller growth stocks, because a lot of them are based on the premise of very, very low discount rates to justify their high evaluations.
And so if you get that continued upward yield pressure, uh, that can potentially put a lot of, uh, downward valuation pressure on some of those, uh, you know, those really high growth stocks that are in many cases, trading at, you know, 30, 40 or 50 times earnings. Don't you find that ironic, which is that. Yeah, the yields rising should be an indication of people's expectations of an improving economy, which is why they're rising in the first place yet.
Like you said, it might push down valuations and some of these growth stocks. How do you as an investor, does that, does that mean? I no longer want good news. Well, it's funny do it depends on what sec you're looking at. And so for example, a lot of people, yeah. Use those growth stocks as bond proxies. They say, you know, I, I, you know, they, they, these other areas that you risky, the energy is all over the place.
Uh, you know, financials are over the place all just by Apple. For example, and they, they buy these growth stocks that are relatively, uh, you know, recession resistant, uh, and that they, you know, they, they, the problem is they end up buying them at almost any price. And so what we've seen is that, you know, over the, over this, this past couple of years, uh, especially in 2020, as you've had these lower yields and these more dis-inflationary expectations, right.
People have piled into those, those growth stocks. And if you do the discounted cashflow analysis, uh, you know, they're more rate sensitive than, than value stocks that have more of their cash flows in the near term at lower valuations. And so as you get rising yields, uh, that's bullish for some of the more cyclical things like, you know, financials or commodities and things like that.
Uh, but potentially it puts pressure on some of these extremely expensive growth stocks that have been essentially serving as bond proxies because people didn't want to venture. And some of those more cyclical industries. Okay. And what about goals now? You mentioned that, uh, rising yields, uh, could happen as a result of inflation expectations.
Well, isn't that just ironic again, because gold in itself, as opposed to be an asset that protects you against inflation yet when you have higher inflation expectations, yields rise, and that pushes gold down where at least weighs it down. So how do you as an investor, how do you, you know, meander around this discrepancy?
Yeah. The main discrepancy is that, you know, gold is not exactly an inflation hedge. It's a hedge against, uh, negative, real yields. And so even if you look back in the seventies, the two big spikes that gold had were really during the two periods of time, the mid seventies, and then the very end of that period where negative, real yields got down to negative 4%.
Uh, and so th those are the periods where you had that big spike in gold. And for example, if you look at the 1980s, uh, you know, inflation was still running pretty hot. But real yields were positive because Volcker had jacked up the interest rates. Uh, and so you could get compensated for that inflation with positive, real yields.
And so what gold really does is protect you from an environment where inflation is, is much higher than the bond yields. And that's what we've seen over in 2020 is that you saw, you know, gold, uh, you know, over the past couple of years, gold had a pretty big appreciation because it was protecting against that.
But now since about. You know, late summer of 2020, uh, negative, real yields had been roughly flat. They hit it bottom of negative 1.08% on the 10 year. Uh, and that's been kind of choppy and sideways since then, which is why we've seen some consolidation and gold. I do think as you look out a couple years, maybe in late 2021, uh, I do think that inflation could rise faster than bond yield, especially because the federal reserve has some tools they can use to suppress the long end of the curve.
And keep that, you know, submerged below the inflation rates and if that were to happen, uh, that'd be very good for the precious metals and particularly gold. Who could you very quickly and in layman terms, describe to somebody with very little financial, um, backgrounds to, uh, as to why they should buy gold.
The purpose of buying gold, because. As we, as we've examined gold hatch actually has a very inconsistent track record of hedging against inflation. And it has a almost non-existent track record of hedging against equities, uh, equity volatility that that correlation is near zero. So why, what what's the point is my question.
Yeah. So mostly it's a replacement for things like treasuries and other low risk assets. And so if you look at treasuries, for example, there were decades in time where they were great investments because they paid you a yield that was a notably higher than inflation rates. Uh, and so for example, inflation is 3% and the treasury 6%, uh, which it wasn't in, in many prior decades, you could buy that treasury and earn in a compound, a positive, real return and grow your wealth.
The problem happens is that if, if. Bond yields get so low, uh, either due to the, you know, the federal reserve, uh, suppressing yields or due to other factors. And let's say you have a 1%, uh, ten-year treasury, uh, but inflation is 2% or 3% while you're just, you're losing, purchasing power by holding that treasury.
And it's very unattractive to do so. Uh, now. Gold is a yield this asset. And if anything, there's a slight negative yield because you're paying you the security costs or, you know, transportation, shipping, all the, all these kinds of, you know, frictional yeah. Storage. Uh, so it's it, you know, but you can basically call it a zero yielding asset, however, unlike treasuries and dollars, it's a scarce asset.
And so there's about one ounce of gold per person in the world, estimated by the world gold council. Uh, and so they're not really making more of it at least compared to the population growth. And so it's kind of has that built in inflation hedge in the sense that as broad money supply increases over time, uh, gold does, uh, gradually appreciate it.
Just doesn't have these big spikes. Um, last you have these dips in the negative, real yield. And so it's really kind of that protection against periods of time where treasuries are failing to keep up with inflation, which is what we've seen over the past couple of years. And I think we'll expect to see, but not in a straight line.
I think we'll still see gold likely do well in the years ahead. Uh, Lynn finally. Spoken a lot about the economy and different assets. Let's finish up by talking a little bit about yourself because we never had a chance to, uh, introduce your background to the audience. I read your bio and you have actually an engineering background.
I'm curious to how you transitioned into financial research and macro research. Well, it's funny. Cause I, you know, my first passion was investing, uh, before I went into, into engineering. Uh, when it came time to go to university, I also had an interest in technology, uh, and for practical purposes. So I, I went into engineering, uh, but then, you know, after that, you know, there's a lot of it's numbers based, right?
So it's kind of the same overlapping interest is anything sort of quantitative. And so I kind of take that quantitative background and apply it to engineering and, you know, One of the analogies I use is like control systems, you know, in engineering, uh, you have the control systems where like, if something happens that the system has an automatic response to it and it kind of keeps pushing it down.
And I view macro economics in a similar way. When you have a response function, when you have like a catalyst that happens, there's always a response function to look for. And that, that kind of trips up a lot of investors. Uh, whereas I try to incorporate that into my analysis and see these kind of, uh, natural kind of response buckets.
Functions that happen? Well, I guess the main difference for me is that the human psyche is more irrational and less predictable than a machine. Is that correct? Exactly. And that's why, you know, it's, it's, you can't use that type of logic to predict what's going to happen in say a six week or a six month period.
Uh, but instead, what you can do is kind of. Uh, catch these long-term fundamental trends of how it's gonna affect the cash flows of companies. What things are are cheap or expensive in an evaluation sense? I kind of looked through a lot of that shorter term noise, which is very, you know, driven by psychology.
So for somebody who is also interested in macro economics, what would you advise them to do to learn more about the subject? If they didn't have a background to begin with? Let's say they started with engineering or anything else. Uh, how would you, how would, how would, should they make that transition if they also want to study the subject?
Well, I think there's a lot of great books on this, on the, on the, you know, the variety of different subjects within macro. Uh, but then there's also, you know, I, I personally find going back and looking at numbers helps just to seeing how different asset classes performed in different monetary and fiscal environments over, you know, the past a hundred years, 120 years.
You know, kind of as far back as really reliable data goes and, and, and seeing for yourself, and then kind of drawing your own conclusions rather than relying on the work of others. Yeah. I, I worked in macro research before, um, joining Kiko and one of the major challenges that researchers had to overcome that I've noticed is, uh, is identifying spurious correlation.
So you put two variables together. They seem to have a correlation and I think oil and you think, well, they, they must have, they must have a relationship, but very often times they don't. Uh, so, you know, when you just do the math and crunch the numbers, how do you then add the fundamental were more qualitative aspects, your work and say, well, you know, just because cheese sales have gone up as nothing, and at the same time as bond yields, it doesn't mean she sales have anything to do with bond deals.
Exactly. Yeah. Th th you have to go back. It's kinda like that, that analogy like, uh, ice cream sales and shark attacks are highly correlated. Right. And it's because they both happen in the summer. That's when people, you know, do, you know, do activities that would anyway. So if you, if you kind of go back in history, you can find a lot of these correlations.
And I think the key thing is a soar through, you know, make sure you understand the logic of why one should lead to the other. Right, because if you can't do that, like you can't argue why ice cream consumption should lead to shark attacks, unless you realize that there's a third variable involved. And so I think that's the key thing is, you know, looking at the numbers, but then also having a framework, including that kind of control system response that I talked about before and being able to understand, and that's where, you know, some of those history books help, because you can see why policymakers did certain things.
Why did they raise rates? Why do they suppress rates? Why, you know, what were they talking about at the time? What were they concerned about? And I think that that combination of financial history with the numbers really helps put things into perspective or then a fantastic update as usual. Thank you very much for coming on the show today.
Yeah. Thanks for having me. And thank you for watching Kichler news. I'm David Lynn. .