Gold Alert
September 28, 2020

The gold price held near $1,295 Monday as the price of gold hovered within 0.4% of its $1,301 all-time high. The SPDR Gold Trust (GLD), a proxy for the gold price, finished higher by $0.04 at $126.72 per share. COMEX gold futures for December delivery rose fractionally, by $0.50 to $1,298.60, but managed to settle at a new record high on a closing basis.

With the gold price continuing to outperform stocks and cyclical commodities in 2010, debate has intensified over how much upside is left in gold’s bull market. One of the most successful investors of this generation, John Paulson, the hedge fund magnate who rose to fame for shorting securities tied to the housing market prior to the financial crisis of 2008, recently expressed his bullish outlook for the gold price.

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In a speech at the University Club in New York City, Paulson provided his broad outlook on several areas of the financial markets – including stocks, bonds, real estate, the Federal Reserve, and the price of gold. Paulson reiterated his bullish call on stocks, noting the historically large discrepancy between the equity earnings yield of 7-8% and the 10-year note yield of 2.6%. Furthermore, because of his belief that the Federal Reserve will continue to implement quantitative easing measures, Paulson is expecting substantial inflation in the next several years. The noted hedge fund manager stated that low double-digit inflation is possible by 2012. Accordingly, Paulson is shorting longer-dated treasuries through 5 and 7 year calls on the 30-year Treasury bond.

In light of pending inflation, Paulson stressed that investors do not want to own long-dated liabilities, but rather should issue them. One of the most efficient ways for people to take advantage of this is through mortgages on residential real estate, noting that now is the best time in 50 years to purchase a home.

As for the gold price, Paulson remains very bullish on the yellow metal, noting that the price of gold has been highly correlated to the monetary base for as long as his firm, Paulson & Co., has tracked the data. Given his expectation for further money printing by the Fed – and that in 1980 the gold price rose by 100% more than the correlation implied – Paulson noted that the price of gold could hit $2,400 based only on monetary expansion, and as high as $4,000 per ounce based on a projected overshoot. Lastly, he noted that 80% of his assets are denominated in gold – a strong indication of his disdain for fiat currencies.

While Paulson has a very impressive investment track record and deserves considerable attention, it is important to point out several items that he did not address. First is his bullish call on equities; according to Dow Theory Letters founder Richard Russell, the longest-running investment letter author in the business, stocks are substantially overvalued by historical standards. The current dividend yield on the broader U.S. market is near 2%, while the price-to-earnings ratio on the U.S. market stands at approximately 20. According to Russell, stocks are presently “not priced for profits” from an investors’ standpoint. Secondly, rising interest rates would cause significant problems for the broader economy, with the effects of compound interest significantly raising the U.S. national debt, causing declines in small businesses lending, and providing difficulty for the plethora of adjusted-rate residential mortgages and commercial real estate debt that matures in the next several years.

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In terms of the gold price, Paulson pointed to gold’s parabolic rise in 1980 and his expectations of a repeat performance. As written in these pages on numerous occasions, one of the primary gold price catalysts has been Fed monetary policy, which has led to an era of low to negative real interest rates. In such a climate, where the opportunity cost of holding a sterile asset such as gold that pays no rate of interest is negligible, the gold price has historically racked up large gains. Until the point that a decent rate of return on capital can be earned, gold will have a solid fundamental underpinning that should lead to a series of higher lows and higher highs.

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