Gold ETFs Vs. Bull Markets
The four largest gold exchange-traded funds (ETFs) by assets are the SPDR Gold Trust (NYSEARCA: GLD), the iShares COMEX Gold Trust (NYSEARCA: IAU), DB Gold Fund (NYSEARCA: DGL) and the ETFS Physical Swiss Gold Shares (NYSEARCA: SGOL). These ETFs were launched in November 2004, January 2005, January 2007 and September 2009, respectively, so there have only been two extended bull markets since such products came into existence. The primary factor influencing gold prices is global inflation, especially of the U.S. dollar. In normal bull markets caused by fundamental economic strength, inflation is low as unemployment falls and productive capacity utilization rises at the onset of a cycle. As the economy approaches peak conditions, inflation begins to increase, causing gold prices to rise. As such, a normal maturing bull market is indirectly related, and positively correlated, to gold prices. However, complicating factors can obscure this relationship.
Bull Markets Since the Launch of Gold ETFs
Throughout the mid-2000s, leading up to the 2008 financial crisis, U.S. equity markets experienced a significant bull run. During this run, ETFs launched by SPDR and iShares were designed to track gold's performance. From January 2005 to October 2007, the S&P 500 appreciated 29.4%. Over this same period, GLD and IAU appreciated 68.5 and 82.2%, respectively. Between the fall of 2011 and the spring of 2015, U.S. equities experienced one of their greatest growth periods, with the S&P 500 appreciating 80% and the Russell 2000 Index gaining 84%. Over the same period, GLD, IAU and SGOL all fell 36%, while DGL declined 39%.
Differences Between Bull Markets
There have only been two extended bull periods since the major gold ETFs were launched, and the correlation between gold and equities was different in each case. In the first case, the year-over-year percentage change in the U.S. Consumer Price Index (CPI) was relatively high, never dipping below 2.5% until the third quarter of 2006. In contrast, the year-over-year change in the CPI rarely rose above 2% from May 2012 to January 2016, with the changes falling into negative territory for multiple months in 2015. The implied five-year, forward inflation expectation rate published by the Federal Reserve dropped below 2% in September 2011 before recovering to a more historically normal level, and then dropped precipitously from August 2014 to February 2016 when the figure fell below 1.5%.
These differences illustrate the inconsistent relationship between gold and equities, as the bull markets occurred amid different inflation environments. In the mid-2000s, the market was catalyzed by perceived economic strength. Business fundamentals were considered sound and expectations of future growth were high, causing equity prices to rise. As economic growth cycles mature and approach peaks, unemployment is usually low and productive capacity utilization is high. These conditions lead to rising wages and increasing prices for goods and services, which are the primary drivers of inflation. Therefore, it is common for healthy economic growth to be accompanied by inflation, and gold has been shown to correlate positively to inflation. From 2005 to 2007, the CPI exhibited relatively high growth and forward inflation expectations were also relatively high, catalyzing gold prices.
The U.S. bull market between 2011 and 2015 occurred amid historically unique conditions. Throughout this period, there were fundamental weaknesses in the global economy and unprecedented monetary policy conditions. Interest rates were at historic lows in many large economies following expansionary monetary policy enacted in response to the preceding recession. South American economies were dealing with protracted, complex economic downturns. Chinese output appeared to be slowing, creating a drag on regional and global economic activity. Fiscal issues in certain European economies created concerns and raised the threat of financial contagion. Given all of these conditions, investors grew skeptical that economic growth would naturally spur inflation, as high unemployment and low capacity utilization created obstacles to wage and price increases. There were also concerns that central banks lost efficacy after being overextended from the previous turmoil. Low inflation expectations provided no support for gold prices. These impacts were exacerbated by U.S. dollar appreciation and increased demand for U.S. equities due to weaknesses in other regions.
A hybrid security combines two or more financial instruments into one security.
Hybrid securities usually contain debt and equity characteristics. The most common is a convertible bond, which corporations issue and investors may convert into the company’s common stock at their discretion. A convertible bond resembles an ordinary bond, but its price rises and falls with the company’s stock.
Hybrids are bought and sold on exchanges. They may offer fixed or floating rates, and pay returns as interest or dividends. Some return to their face value at maturity, and some offer tax advantages.
New hybrids are created all the time to satisfy sophisticated investors. But some are so complex that they’re difficult to categorize as debt or equity. Investors should review them thoroughly before investing.
Hybrid securities carry unique risks and rewards. A convertible bond will offer greater potential for appreciation than a regular bond. But it will also pay less interest and still pose the risk that the underlying company may default on coupon payments, or on paying the principal at maturity. Often, the many risks hybrids present create a security that’s not worth the reward.
The four largest gold exchange-traded funds (ETFs) by assets are the SPDR Gold Trust (NYSEARCA: GLD), the iShares COMEX Gold Trust (NYSEARCA: IAU), DB Gold Fund (NYSEARCA: DGL) and the ETFS Physical Swiss Gold Shares (NYSEARCA: SGOL). These ETFs were launched in November 2004, January 2005, January 2007 and September 2009, respectively, so there have only been two extended bull markets since such products came into existence. The primary factor influencing gold prices is global inflation, especially of the U.S. dollar. In normal bull markets caused by fundamental economic strength, inflation is low as unemployment falls and productive capacity utilization rises at the onset of a cycle. As the economy approaches peak conditions, inflation begins to increase, causing gold prices to rise. As such, a normal maturing bull market is indirectly related, and positively correlated, to gold prices. However, complicating factors can obscure this relationship.
Bull Markets Since the Launch of Gold ETFs
Throughout the mid-2000s, leading up to the 2008 financial crisis, U.S. equity markets experienced a significant bull run. During this run, ETFs launched by SPDR and iShares were designed to track gold's performance. From January 2005 to October 2007, the S&P 500 appreciated 29.4%. Over this same period, GLD and IAU appreciated 68.5 and 82.2%, respectively. Between the fall of 2011 and the spring of 2015, U.S. equities experienced one of their greatest growth periods, with the S&P 500 appreciating 80% and the Russell 2000 Index gaining 84%. Over the same period, GLD, IAU and SGOL all fell 36%, while DGL declined 39%.
Differences Between Bull Markets
There have only been two extended bull periods since the major gold ETFs were launched, and the correlation between gold and equities was different in each case. In the first case, the year-over-year percentage change in the U.S. Consumer Price Index (CPI) was relatively high, never dipping below 2.5% until the third quarter of 2006. In contrast, the year-over-year change in the CPI rarely rose above 2% from May 2012 to January 2016, with the changes falling into negative territory for multiple months in 2015. The implied five-year, forward inflation expectation rate published by the Federal Reserve dropped below 2% in September 2011 before recovering to a more historically normal level, and then dropped precipitously from August 2014 to February 2016 when the figure fell below 1.5%.
These differences illustrate the inconsistent relationship between gold and equities, as the bull markets occurred amid different inflation environments. In the mid-2000s, the market was catalyzed by perceived economic strength. Business fundamentals were considered sound and expectations of future growth were high, causing equity prices to rise. As economic growth cycles mature and approach peaks, unemployment is usually low and productive capacity utilization is high. These conditions lead to rising wages and increasing prices for goods and services, which are the primary drivers of inflation. Therefore, it is common for healthy economic growth to be accompanied by inflation, and gold has been shown to correlate positively to inflation. From 2005 to 2007, the CPI exhibited relatively high growth and forward inflation expectations were also relatively high, catalyzing gold prices.
The U.S. bull market between 2011 and 2015 occurred amid historically unique conditions. Throughout this period, there were fundamental weaknesses in the global economy and unprecedented monetary policy conditions. Interest rates were at historic lows in many large economies following expansionary monetary policy enacted in response to the preceding recession. South American economies were dealing with protracted, complex economic downturns. Chinese output appeared to be slowing, creating a drag on regional and global economic activity. Fiscal issues in certain European economies created concerns and raised the threat of financial contagion. Given all of these conditions, investors grew skeptical that economic growth would naturally spur inflation, as high unemployment and low capacity utilization created obstacles to wage and price increases. There were also concerns that central banks lost efficacy after being overextended from the previous turmoil. Low inflation expectations provided no support for gold prices. These impacts were exacerbated by U.S. dollar appreciation and increased demand for U.S. equities due to weaknesses in other regions.
A hybrid security combines two or more financial instruments into one security.
Hybrid securities usually contain debt and equity characteristics. The most common is a convertible bond, which corporations issue and investors may convert into the company’s common stock at their discretion. A convertible bond resembles an ordinary bond, but its price rises and falls with the company’s stock.
Hybrids are bought and sold on exchanges. They may offer fixed or floating rates, and pay returns as interest or dividends. Some return to their face value at maturity, and some offer tax advantages.
New hybrids are created all the time to satisfy sophisticated investors. But some are so complex that they’re difficult to categorize as debt or equity. Investors should review them thoroughly before investing.
Hybrid securities carry unique risks and rewards. A convertible bond will offer greater potential for appreciation than a regular bond. But it will also pay less interest and still pose the risk that the underlying company may default on coupon payments, or on paying the principal at maturity. Often, the many risks hybrids present create a security that’s not worth the reward.
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