04-02-2014 11:31 AM
By Arne Espe,
Vice President of Mutual Fund Portfolios
Bitcoin, the digital currency, is being touted as an alternative form of money. It’s not tied to any specific government; it’s not subject to regulation, and it can be purchased as an investment whose value could rise due to supply and demand. This sounds a lot like gold, only without its safe haven attributes. After all, you can’t destroy bullion with a bad line of computer code.
In January and February, gold saw a strong rebound from a poor 2013 before it slipped back about 3% in March as geopolitical tensions abated and the Federal Reserve continued to taper its monthly bond-buying program known as “quantitative easing.” For the year, gold is up about 8%. We don’t disagree that gold faces some headwinds in the short term, but over the long haul, we believe a small portfolio allocation to gold can benefit many investors.
Often the case for gold is made as a hedge against rising inflation, which, as measured by governments, is not much of an issue now in the developed world. In fact, central banks in the U.S., Europe and Japan would actually like to see a little more (but not too much) price inflation as an indicator of improving economic activity.
Our case for gold over the long term is not just about official inflation rates but also about long-term currency value. Since early in the new millennium, the supply of money in circulation around the world has increased at a double-digit annual rate, and it’s still growing. The Bank of Japan and the European Central Bank are both talking about QE programs to spur economic expansion, and even though QE is being tapered in the U.S., the Fed program is still creating tens of billions of new dollars every month.
Quantitative easing is, at its essence, a form of currency devaluation — as the creation of more dollars, euros or yen makes each existing dollar, euro or yen worth a little bit less. One advantage of a weaker currency is that exports from that country are cheaper for overseas buyers, which can create a competitive advantage compared to exporters with stronger currencies. And it can be more expedient to pay down the massive sovereign debt loads carried by developed nations — U.S. federal debt is roughly equal to GDP, while Japan’s debt is more than double its national output — with devalued currency than through greater economic growth. Since gold supply cannot be increased as government policy changes, it can serve as a hedge against currency devaluation.
We believe a small allocation to gold or gold-related equities may have a place in a well-diversified investment portfolio, as the price of gold often zigs when the price of other assets zag. Earlier in the year, gold rose as emerging market stocks slid after the U.S. began to trim QE. In March, gold corrected as U.S. stocks climbed. The Standard & Poor’s 500 index started April with its seventh all-time-high closing level this year, but we believe the market is overvalued. On the bond side, we see some attractive valuations in high-yield, but not in Treasuries. From a fundamental perspective, we think gold may be at a decent entry point after having given up a third of its value over the past two years.
The biggest threat we see to gold would be if the Fed quickly and significantly raises short-term interest rates, which would run counter to the guidance and public statements being issued out of Washington. It’s worth pointing out that stocks and bonds also would not fare very well in that scenario.
USAA Investments Managed Portfolio Outlook
Our view of caution toward U.S. equities remains unchanged: We are underweight U.S. large caps and small caps. We are also tactically underweight fixed income. We remain slightly overweight cash in our diversified managed portfolios.
We also are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund also provides potential protection against the risks of long-term inflation.
Emerging markets represent another opportunity. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. They offer both an interesting long-term prospect for growth and compelling valuations. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.
As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited to your individual goals, objectives, risk tolerance and time horizon.
This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.
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