Gold on Gold with Max Gold, Head of Gold Strategies at State Street Global Advisors

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley and I'll be your host. We've got a good one for you today. We're talking about gold, an asset class that's often misunderstood, with Max Gold, the head of Gold Strategies at State Street Global Advisors. Max, thanks for being on.

Max: Yeah, it's great to be here, Stewart.

Stewart: We're thrilled to have you. It is an asset class that has its own name for people who invest in it, right? Gold bugs and gold, all these names, and I've always been fascinated by this asset class and I've never ever had the chance to talk to somebody who's really, really a learned professional. I'm thrilled to have you on today, but before we get going there, let me ask you the questions that we ask everyone, which is where did you grow up? What was your first job of any kind? Not the fancy one, Max, the one that's humbling, and a fun fact.

Max: Yeah, I grew up in New Jersey, I'm a northeast guy through and through my whole life. I went to school upstate New York, lived and worked in Boston for a while before settling here right now in the New York area. That's really my path in terms of geography. In terms of my career, my first real job was with JP Morgan, working in their private bank in the finance industry. But before that, my actual real job, I worked as a cashier at a small local grocery store. Learning about sales revenues, how to work the cash register was really the first summer job I had when I was in high school.

Stewart: Outstanding. What's the fun fact?

Max: The fun fact for me is that yes, my name is Max Gold and I am the head of Gold Strategy, but beyond that, I do take a look at markets from more of a global holistic standpoint. I think to add on top of that, I'm a diehard Yankee fan, New York Yankee fan, love baseball, have my whole life, have played when I was in high school. I follow the start of the season recently very closely and look forward to that.

Stewart: That's fantastic. Before we hit the record button, I said, "Can I call this podcast Gold on Gold?" You said, "I'd love to tell you that you're the first one that ever came up with..." I thought it was really creative Max, but not so much. Right? Let's go with some questions here. I think gold's an often misunderstood asset class as to how it's going to perform and how it's going to behave, just at a high level, what drives the gold market?

Max: Yeah, I think that's a great starting point because when you're talking about gold, it can be a very polarizing asset. A lot of people either love it, a lot of people hate it, and there's I think much more room in that middle ground of what drives it from a market standpoint and then really how to utilize it from an investment standpoint. Really, when you're talking about gold, what drives the gold market? I like to take a step back and then really think through what are the big drivers over different periods or different horizons?

When you're talking about gold, in the short term, I think there's some key indicators of what drives the market in terms of the price. Over the medium term, I think there's a separate set of factors, and over the long term, those are really the long-term drivers that help set the directionally the floor and the ceiling in terms of the outlook for the gold market over a strategic long-term period, 10+ years if not longer.

Really, when you break down those factors, really within that realm of are you looking short-term tactical, medium-term strategic, or even longer-term strategic asset positioning, it really depends on that time horizon that you want to evaluate of what the important drivers for gold are. To your point, there are a lot of misconceptions, a lot of associations of how gold should perform or what expected perform based on history, based on the current market drivers today. But really, when you're looking at gold, the market itself, I like to think break it down as short-term, medium-term, long-term. Flows, then factors, then fundamentals are really the most important contributors to what drives gold in the outlook of the market itself.

Starting with the short-term flows, I like to look at what's happening from an investment standpoint, from a technical standpoint, what's happening with positioning amongst futures markets? What are the traders in the large markets of gold doing? What's happening with ETFs and flows in terms of money moving around in the market and what's happening more of a technical standpoint. By no means am I a market technician, I'm more of a macro strategist from my background, but it's important to pay attention on the shorter-term technicals. What's happening towards sentiment, the outlook, are investors and market participants bullish bears for gold in the short term? That can help signal what's going to happen on that short-term period for gold on a flow positioning sentiment standpoint.

The medium term is really where I spend most of my time evaluating gold markets and the outlook for the asset class. That's really where factors come into play. What are those important explanatory variables that are tied more towards macroeconomics, more towards a lot of factors that we talk about from an investment standpoint day by day?

For gold specifically, the important factors that have the biggest explanatory power towards the outlook for gold in my mind, include the US dollar interest rates, the overall level of interest rates, as well as the change of interest rates, inflation levels, and how they tie towards interest rates as well in that standpoint as well as the overall level of risk in the marketplace. Is there a tremendous amount of risk on sentiment, risk off sentiment? Are markets and investors taking on risk assets or are they not? Are they looking for more defensive positioning? That overall risk environment can play an important factor for gold over the medium-term alongside with those other factors including the dollar, interest rates, inflation.

I do think that when you're looking at over a medium-term, say there's no hard and fast period, but I think about it more of a 1 to 5 year period, those tend to be those cycles of inflationary cycles, growth cycles, interest rate cycles. They tend to be the more prominent drivers for gold over the medium-term. Then shifting to long-term, this is where I spend a lot of my time as well, evaluating gold market, what are the fundamentals for gold? What's happening on the demand and supply side?

This is traditionally where you would think that what would drive gold as a commodity, what would be the biggest important drivers? It is especially over the long-run, and we do spend a lot of time evaluating what's happening with demand for gold. The gold market from a demand standpoint is very different, very unique versus other more traditional commodities like copper, or oil, or natural gas, or corn, or coffee. When you look at gold, it does stand alone from a fundamental standpoint in terms of its supply/demand dynamics.

When you're talking about demand for gold, it's very interesting because the breakdown of demand can be basically summarized in four key sectors of demand for gold every year globally. That includes jewelry demand for gold, which intuitively makes a lot of sense when you're thinking about demand for gold for jewelry, its aesthetic appeal, obviously it has a lot of traditional beauty and aesthetics for jewelry manufacturers, fabrications from that standpoint. Interestingly, this tends to catch a lot of people who are less informed of the gold market off guard. When you look at jewelry demand for gold, it accounts on average 40% to 50% of global demand every year. It is the biggest source of demand for gold globally across developed in emerging markets every single year for gold. It's critically important what's happening with the jewelry market for gold.

Additionally, when you look at those other demand sectors every year for gold, we have technology industrial demand for gold that averages about 10% to 12% every year and that tends to be associated most closely with electronics. When you think about gold, you tend to think about from an investment prism. But additionally, when you think about go from a technological application, it is hugely important. It's a great conductor of electricity, it's heat resistant, it's malleable, it's ductile. It's a great material from a technology and industrial application standpoint that's used in a plethora of different industries. The biggest one most prominently being the electronics industry as a conductor. That counts for about 10% of demand.

Then investment demand, which makes up the bulk of the conversations that I have, and that average is about 25% to 30% of demand every year. But that's not just to say ETF demand or flow demand in traditional investment vehicles that are quoted and traded on TV or online every day, a large part of that investment demand is actually anchored into retail bar and coin demand. Think of, say, one-ounce bars of coins and bars out there, and a lot of that demand is actually concentrated into emerging markets. Think India, China, Southeast Asia, the Middle East. That tends to be a very sticky source of investment demand that traditional retail bar and coin demand. On the flip side, we also have investment flows, futures, et cetera, which ties to that as well on the physical side.

Then rounding out that demand equation, we have jewelry technology, investment demand, is central bank demand. This has been a very interesting area of demand that's seen tremendous growth over the last 10+ years. We continue to see that even last year where central banks remained net buyers of gold. In fact, last year in 2022 was the biggest year on record over a thousand metric tons of gold purchased by central banks globally. That tends to be an ongoing trend.

We remain bullish and supportive of that central banks will remain net buyers of gold giving further tailwinds towards the outlook for gold. Again, a very long-winded way to summarize your question of how do you think about gold, but again, I think of it from a short-term, medium-term, long-term standpoint.

Short-term flows, medium-term factors, long-term fundamentals being supply and demand. Especially on the demand side, investment demand, central bank demand, jewelry demand are tremendously important. I follow closely different various trends which impact those different sectors day by day.

Stewart: That's really helpful. We have a number of friends that are CIOs and they've given me a special permission slip to wear a CIO hat whenever I'm doing podcasts. Whenever I talk to a guy like you, I've got my insurance CIO hat on. What role should gold serve among investment portfolios? And specifically insurance investors are the lion’s share of our audience with regard to as much insurance viewpoint, as you can sprinkle into that answer.

Max: Yeah, I think when you look about what's the potential investment utility or portfolio utility that gold can bring to the table for diversified asset allocations, I do, again, I break it down to sort of three different utilities that gold can serve depending on what you're looking to use it for. The biggest and first and foremost is risk management.

I think gold's a core risk management tool for every portfolio, every asset allocation strategy out there. It is a persistently low correlating asset to financial assets, particularly stocks and bonds over time, that low and even negative correlation in certain asset classes and recently it's persisted over time, over decades plus. It is a very unique asset class and again, that low correlation to stocks, bonds, alternative asset classes across the board globally really stems from that fundamental source of demand.

Again, I spent some time explaining that because that's really the source of that low investment correlation to global equities, global fixed income asset classes, global real assets, global alternatives, and gold really sort of stands the test of time or it really is the only asset that I see persistently maintaining that low correlation to risk assets. I think of gold first and foremost as that source of portfolio diversification and that core risk management tool. It's not really in your portfolio to dial up your return or produce cash flows per se, but it is in your portfolio to serve as that ballast, that fulcrum of dialing up and dialing down your overall risk exposure to your portfolio, however that may be constructed.

Again, gold is efficient in terms of how it provides diversification. Again, for example, say you have 10% of gold in a traditional stock bond portfolio, it's going to actually contribute less than 10% on a risk contribution standpoint. Basically it takes up less space in your portfolio on your risk weighting than it takes up in your asset allocation waiting space. Long story short, that's not the case for a lot of other diversifying asset classes out there like traditional commodities, real estate, other alternative assets that tend to be viewed in growing attention in periods of high volatility or recession or slowdown.

I do think that now is a great time to be looking at those asset classes, but I think gold when you compare head-to-head stands very differently. Core risk management tools, how I think about gold as a source of portfolio diversification, improving your Sharpe ratio, reducing your portfolio volatility, potentially improving your portfolio return is sort of the first and foremost starting point. Now beyond that, and I think especially for insurance investors' assurance, insurance portfolio managers, and an important aspect of gold that's often overlooked, is its ability to serve as a capital preservation tool.

Often gold is used as sort of an inflation hedge. Really, I think that's a little bit too simplified response in terms of valuing gold. It's great at serving as a store of value asset and especially in an environment where we've seen just tremendous volatility of interest rates over the last year driven by the Fed in its rate hiking cycle to put a lot of downward pressure on bond valuations, on fixed income valuations.

A lot of questions I've gotten from asset owners, asset managers, institutional clients, pension and clients et cetera, is how do we rethink our asset allocation, our risk taking, and what can we add to the portfolio to provide diversification without giving up too much risk exposure? I think gold has been a great compliment towards that struggling fixed income sleeve of a lot of institutional investor portfolios over not just the last year or so, but really over the last 5 to 7 years as we've seen, again, gold serving as that low correlating asset, that source of portfolio diversification against risk assets on the equity side, or are there financial assets side that maybe have a higher risk weighting or higher volatility. But again, it does contribute in efficient manner similar to how bonds have historically into your portfolio. I think that's only grown in recognition and grown in usage as we've seen. Again, money flows going into the gold market increase over the last few years, and I do think that's been sort of a paradigm shift in terms of portfolio construction that investors are shifting towards. It can serve as sort of that capital preservation tool, keeping up with inflation, providing that diversification, that's a liquid asset; another aspect of gold that's often overlooked. Its liquidity is very deep and trades a significant amount on the OTC, the over-the-counter market for gold every single day.

I think if you're looking for a long-term diversifying asset that can keep up with inflation, provides stability for your portfolio diversification, as well as tremendous liquidity, which only increases when we see volatility increase with gold market. For example, March of 2020, we saw obviously a breakdown of liquidity in the capital markets, gold liquidity maintained. Again, it is a great source of liquidity from that standpoint. Summarizing how we think about gold from a portfolio utility standpoint, again, risk management and capital preservation are qualities that I apply towards gold especially that may be applicable towards insurance investors specifically.

Stewart: That's really helpful. Your idea, the concept of taking up less risk space than it is allocation. That's an interesting concept. Just kind of keeping my CIO hat on for a minute, insurance companies' largest asset class almost always is investment grade fixed income. Inflation deteriorates or erodes the value of those bond portfolios. At the same time, inflation ramps up the value of future liabilities. Insurance companies have a double-edged sword when they're faced with inflation.

The question I guess I'd come out of that is, is gold a good inflation hedge and is there, for example, a worker's comp carrier has got medical inflation to deal with when they're caring for patients over long periods of time, health insurance have the same thing. Are there aspects of inflation that gold is a better hedge than other aspects? I don't know if that helps or hurts, but give it a try.

Max: Yeah, no, I think this question specifically is one of my most favorite misconceptions about gold that I often bring up with clients and investors. Gold tends to be associated as a pure inflation hedge. Again, that's a misnomer in terms of title. I think if you're looking to hedge specifically price inflation through indices like CPI index or the PCE index, there are other instruments that are specifically designed to keep up with that at a very high correlation as measured in terms of gold as a price inflation hedge. It does a great job during the very extremes of significantly high inflation as well as on the flip side, significant deflation and great examples over the history in the US that we've seen of that happening is during the Great Depression where we saw prices fall by 2/3, gold actually was appreciated during that period. That was a period of historically significant deflation.

On the flip side in 1970s during the stagflationary period, over that decade, we saw obviously inflation hit double digits in the US as well as around the globe. Gold again saw a very strong performance at protecting against the extreme. I think gold does a great job of protecting against the extremes of price and stability on both sides of the spectrum, inflation and deflation. The issue is that a lot of times we're spending most of the time in markets in that middle ground and when you compare gold's overall inflation beta as measured from a price index standpoint like CPI, it keeps up broadly with a diversified stock bond portfolio, but there are other assets that have a higher correlation or higher beta to purely price inflation.

That's not how I really define gold in terms of its inflation hedge characteristics because a lot of time is spent on price inflation and I understand that's hugely important for insurance CIOs and focus from cost of living adjustments. But another risk to their portfolios that's often overlooked that I think is beginning to get a lot more recognition as of late, is the exposure to the US dollar. When you think about inflation from a monetary standpoint, what is monetary inflation's impact to investor portfolios and positioning? That's really where I think gold stands much more prominently over history, because the way I try to summarize it, gold's not an inflation hedge, it's a stored value asset. What it does, is it broadly keeps up with price fluctuations over time in conjunction with depreciation and devaluation of currencies. For investors in the US that's most dominated by US dollar exposure.

When you think about gold and its ability to protect against monetary inflation as translated to a weakening dollar or devaluation of a fiat currency, it does a tremendous job of keeping up with that as well with broadly price fluctuations over time. That's the way I think about gold, is not as a price inflation but as a store of value asset. You can see that, again, we mentioned central banks have been net buyers of gold for the last 13 years consecutively.

I do think that again, the rationale for them to buy that is it's a great reserve asset, it has liquidity, it broadly can maintain its value over time. It doesn't have any counter party hedge or credit risk hedge. I think from that standpoint, gold as a store of value asset has that track record and it makes a lot of intuitive sense given its characteristics. That's how I summarize really gold as an "inflation hedge," that's a bit of a misnomer really stemming from the late '70s, early '80s, when we saw double-digit inflation develop markets and we saw the gold price rally to an all-time high at that point of about $800 US.

But really what was happening then was, we saw interest rates fall deeply negative because of high inflation and that's what sparked gold much more dramatically. When you look over the long-term track record, gold has a great history of providing a store of value of preserving purchasing power and spending power over the strategic periods. I think that's a great way to apply gold for asset allocation purposes amongst institutional investors, insurance investors that are looking for, again, that ballast in their portfolio that can certainly protect against the shocks on a price inflation standpoint, but as well as protect against that risk of a weaker or a lower dollar alongside with preserving your spending power over the long run.

Stewart: That's really helpful and I appreciate the distinction. Let's talk a little bit about, you'd mentioned other commodities briefly, how does gold differentiate itself from other commodity investments?

Max: Yeah, this is another common question I get, because when you're looking at other commodities, and just to summarize, what are those commodities and you're talking about the broad commodities that are often traded, they're liquid investible. That includes really the energy sector, oil, natural gas, for example, the agricultural sector which is made up of the soft, such as coffee as well as different commodities on the agriculture side like wheat, corn, as well as the industrial metals and then precious metals. The industrial metals being most dominated by copper, aluminum, nickel, zinc, the likes of that as well, steel. Then the precious metals including gold, we have silver, platinum, and palladium.

Amongst that list, which is again, I didn't cover all those commodities, but just amongst those sectors of commodities of energy, agriculture, industrial metals, and precious metals, gold really actually stands alone. It's a very unique commodity when you compare it to those peers. The reason being, again, going back to those demand sectors of a gold, I mentioned at the top of this conversation, when you look at what's the biggest driver for gold, what is the most geared towards, it's a very diversified source of demand. We have both cyclical and counter-cyclical sources of demand for gold that come online at different phases of a full market cycle or full business like cycle.

When you compare that to most other commodities, they are much more highly geared towards the growth cycle, the economic cycle, or even the industrial production cycle. They tend to carry a much more high beta or correlation to rising growth towards increasing industrial production manufacturing as that makes intuitive sense. When you need energy, you need oil, you need gas, you need inputs to produce goods and services. That does carry a much highly geared exposure to growth and output from that standpoint.

Gold is a little bit more unique in terms of its biggest source of demand is jewelry. Now that does have growth sensitivity, but it's much more highly levered towards the consumer, less so industrial uses. When you compare it to, say, copper, copper is going to be much more applied in terms of source of demand every year to the industrial cycle and gold a little bit more less sensitive to that. Additionally, gold has source of demand of investment of about 30% every year. When you compare that, that's very much a counter-cyclical source of demand compared to the cyclical source of demand for jewelry or technology demand for gold. When you put these cyclical and counter-cyclical sourcees of demand, together that's what creates that low correlation.

Now back to the example of other commodities, again, they are primarily used or consumed as inputs or end products for consumption. They tend to be much more highly volatile, much more geared towards the overall outlook for global growth. They are less really sensitive towards that counter-cyclical ballast of investment demand, especially when you compare to gold in its investment characteristics. Gold really stands apart from the traditional more broad-based commodities in terms of gold really isn't consumed. It's repurposed, but it's extracted. A lot of gold is either used for fabrication in jewelry or technology and then is recycled back into the supply chain or it's cast into bars and coins and put into vaults or storage for investment purposes.

Again, it has a different dynamic compared to the traditional commodity that may be consumed at the breakfast table or as an input for transportation on your commute to your job every day. It's a little bit different way to think about gold and that tends to stand out in terms of its overall performance, especially during periods of high volatility or market selloffs, gold tends to outperform as on broad commodities tend to underperform during periods of recession as overall growth output activity decreases during those periods and gold tends to outperform a sort of a defensive store of value asset or portfolio defensive asset during those periods of turmoil.

Again, that's the key difference between gold and other traditional commodities. I did mention that gold has a little bit lesser sensitivity from a price inflation standpoint, but again, I think that's only part of the difference between gold and other broad commodities. Yes, broad commodities may outperform gold on the upswing during expansionary periods, but they tend to more than underperform gold on the downswing on the other half the cycle. When you look at the full cycle perspective, gold actually is a very different performing asset versus other traditional broad commodities.

Stewart: That's really interesting and helpful. Thank you. As an investor, as an institutional investor and as a personal investor, how can I invest in gold, particularly at scale, if I'm running a $10, $15, $25 billion insurance company portfolio in my allocation there, I need to be able to buy this as an institutional investor. What are my options? I don't know if this is the right way to phrase this, but what's the most efficient way that I can get there?

Max: Yeah, I think when you're talking about investing at scale, particularly from an institutional investor standpoint, there's a handful of options or strategies or vehicles that you can invest in to really capture the benefit of gold, the metal itself. I think the best way really is, again, what we offer here at State Street, we're an ETF business and we have physically backed gold ETFs, as well as other competitor firms out there. I think when you look at that structure, these are liquid vehicles that hold $50+ billion in assets that trade a $billion+. I'm sorry, yeah, a billion plus per day on volume standpoint, these are tremendously liquid vehicles that have been utilized by investors at the institutional level as well as down to the retail level. I think that's one option is a physically-backed exchange traded fund or ETF that invests directly in physical bullion or physical metal itself or gold.

Another common way that a lot of institutional clients, investors I speak to that invest, is through derivatives, particularly the futures market. But again, that carries additional considerations beyond just a pure long exposure to the underlying metal itself through a fund like an ETF. When you're looking at futures, obviously you have the big issue for gold specifically being the roll yield, that negative roll yield, the issue because gold is often and can tango, it's very rarely in sustained backwardation. What that basically means, is that when you have a futures contract or a derivative that matures or expires, you have to roll into that contract again.

Because gold is very rarely in short supply, a feature of gold is that it's stored in vaults available to be brought to the market as a store of value asset, that it tends to be very rarely in backwardation. You're going to most likely have a negative roll yield from a future's position when you add on top of that the spot return or the commodity return for gold and additionally, you have the collateral yield, which is increased and obviously recently with the Fed increasing interest rates, when you put all this together, again, different considerations of how to gain exposure to the gold price, the gold commodity itself.

Then additionally, there are other vehicles out there that don't have direct exposure to gold. For example, gold mining equities or funds and investment strategies like that is one option. Again, certainly a valid option from an investor standpoint. But I like to point out that there is a distinction between equities that invest in natural resources or mining operations that are mining gold, versus gold the metal itself. The biggest being that at the end of the day, those are equity investments.

They carry equity factor risks and tend to perform like equities. Gold again performs like gold itself. It has that low correlation, that protection against sustained drawdowns during tail events that we have in the marketplace, as well as that diversifier aspect for portfolios.

When you're looking at the gamut of how to invest at scale for gold, I think those are really the most common vehicles in conversations I have with clients and investors, being funds like ETFs that invest directly in physical bullion that are vaulted, large bullion bank vaults in different areas around the globe. Derivatives markets, particularly the futures markets. You can throw in swap contracts in there without getting too technical. But again, there's other considerations around costs and trading costs, holding costs, as well as exposures of managing those appeal positions that it does take into account are the skills and other active management to maintain those exposures over time, as well as alongside with those other equity-like strategies for the mining op side of things.

That's how I really think about it from an insurance or institutional standpoint, the biggest vehicles that would be viable options. From my personal standpoint, I think the best option, if you're looking to gain investment exposure, is through an ETF fund like we have at State Street, but I do think that provides ongoing liquidity, an easy way to trade on the secondary market with ease as well as keeping a very low tracking error to the price of gold over time. I think if you're looking to gain exposure to the gold metal itself, the bullion, to benefit from its investment characteristics, I do think that an ETF, a physically backed ETF, like the ones we have at State Street, are some of the better options from a liquidity cost efficiency standpoint, especially for large institutional investors. But again, we have a large amount of intermediary investors and retail investors that leverage our products as well.

Stewart: Outstanding. I've learned so much on this podcast. I really have. I've loved it. I've got one more question for you, and this is new for 2023. I got some feedback that said, "Stop asking people about their 21-year-old selves and ask something new." Here we go. Who would you like to most have lunch with, alive or dead?

Max: That is a good question. Who would I like to have lunch with alive or dead? Again, I mentioned at the top, I'm a big baseball fan, big Yankee fan. Would love to maybe have a round table with some of those baseball greats in the Yankee organization. Babe Ruth, Lou Gehrig, Mickey Mantle, just sort of pick their brain, I think could be an entertaining conversation with those players, but would love to open that up to other baseball greats, Hank Aaron, Jackie Robinson, as well as going all the way back to the days of Honus Wagner, early days of baseball. I think that might be interesting.

Stewart: Yeah, I grew up in St. Louis and it's a hell of a baseball town too. Lou Brock was my guy. I was left-handed. Lou Brock was left-handed, and that's all it took from me. I was hooked. But listen, Max, thanks for being on. I learned a lot about the gold market, I learned a lot about the characteristics and how to think about it, and I just want to say thank you very much for taking the time and for being on.

Max: Absolutely, Stewart. Thanks for having me.

Stewart: We've been joined by Max Gold, head of Gold Strategy at State Street Global Advisors. Thanks for listening. If you have ideas for a podcast, please shoot me a note at podcast@InsuranceAUM.com. If you'll like us, please read us and review us on Apple Podcast. We certainly appreciate it. My name's Stewart Foley, and this is the InsuranceAUM.com podcast.

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