4 Potential Reasons for the Gold Rally

Russ discusses why gold, not a popular asset class until recently, has become so as a hedge.

October was not kind to investors. Not only did stocks suffer their worst monthly draw-down in years, but traditional hedges, such as government bonds, did not rallied enough to offset the losses (see Chart 1). As a result, a typical 60/40 stock/bond portfolio experienced one of the worst draw-downs since the financial crisis.

asset performance monthFinal

Interestingly, gold, largely left for dead, has rallied. Not only has gold bounced, but it has done so despite a steady dollar. Which raises the question: Why is gold rallying now? Here are four potential reasons:

1. Gold got “cheap.”

Over the very long term gold and the U.S. money supply, measured by M2, tend to move together. Changes in gold prices have roughly equaled changes in the money supply, with the ratio tending to mean-revert towards 1. By the end of September, this ratio had fallen to below 0.7, the lowest since 2005. When the ratio is low, defined as 25% below the long-term average, the average return during the subsequent 12-months is 15%.

2. The dollar has stabilized.

While the DXY Index is pushing against the upper end of its five-month range, the dollar has been relatively stable since May. This is important as a rapidly strengthening dollar, as we witnessed last spring, has historically been a headwind for gold. To the extent the dollar has stabilized, this removes one headwind.