Gold prices have been facing pressure for a while. But the best strategy, in my view, is to buy an asset when everyone else is getting rid of it. In addition, there are plenty of factors that can push the price of the shiny yellow metal upwards. The most obvious one is the next recession. I am a great fan of physical gold and silver. But gold ETFs can also be an alternative for investors unwilling to deal with storage issues. The SPDR Gold Trust Fund (NYSEARCA:GLD) is the largest and most popular gold ETF with high amounts of liquidity and low bid-ask spreads. This investment has great potential since investors can take advantage of its linkage to gold prices. GLD also carries its own risks I will explain below.
Labor market
You might be wondering why I started this article by writing about the labor market. Indeed, the demand for both physical gold and gold ETFs is heavily linked to central banks' monetary policies. Central banks, including the Fed, carefully look at two main macroeconomic indicators: inflation and unemployment.
On Friday a non-farm payrolls report for September was published, one of the most important pieces of labor statistics. The market took it like the employment rate in the US is very high and good. Many investors think this would allow the Fed to hike the interest rates even higher, a piece of horrible news for most asset classes.
Let us do a more detailed analysis of the recent jobs report. After 263,000 instead of the 275,000 new jobs, estimated by Dow Jones, were added for the month, the unemployment rate totaled only 3.5%. This seems to be a sound indicator, very close to the levels seen in 2019.
Unemployment rate in the US
However, we can also see there were sufficiently fewer new jobs added compared to the numbers recorded in the previous months of the year.
Below I put a graph giving you an idea by how much the job growth has slowed down.
Non-farm payrolls
You might argue that it's not a big deal. After all, jobs growth cannot last forever. Even though the low unemployment rate is a positive, the labor market seems to have no further growth potential. This is quite a dangerous period for the economy - when growth stalls, there is often an economic decline, also known as a recession.
A recession is near
We are nearing another big problem - many experts argue a recession may be about to come true in the US. One of the most reliable recession indicators is considered to be the Treasury yield spread, the difference between the 10-year Treasury and the 2-year Treasury yields. After this curve gets inverted, on average it takes recession between 6 months and 1 year to come. I have been watching this indicator for a while. It was in the beginning of April 2022 when it first inverted since 2019. This can be seen from the graph below.
It can also be clearly seen that in 2019 the yield curve inversion was very short-lived. The most reliable recession sign is when the curve inverts and stays so for a while. Although no one predicted the Covid-19 pandemic and massive lockdowns, the bond market still flashed a warning signal. But right now the bond market seems to be screaming a recession is near.
It is possible of course the Fed may raise the interest rates at a slower pace than it wanted to. For example, some experts predicted the Federal Reserve might hike by 0.75% if not 0.50% and not 1.25% like many had predicted. In fact, there were some remarks by one of FOMC's members, namely Mr. Evans, expressing concerns over the financial stability that would likely suffer due to highly restrictive monetary policies.
But most of the Fed's members remain hawkish. The most recent example is that of Waller saying the labor market is tight, whilst the inflation readings are high and running. So, he sees numerous rate hikes ahead to get inflation under control.
On the surface, it seems there is plenty of terrible news for the gold market. Indeed, the demand for precious metals always falls when the monetary conditions get tighter, whereas the dollar rises.
At the same time, after the global economy enters recession, the central banks soften the monetary conditions. In other words, they start printing money, thus weakening their national currencies. In this situation, investors seek refuge in real assets, most obviously precious metals and gold in particular.
Price on paper vs. real demand for gold
I am sure you are wondering why investors are ignoring such a wonderful opportunity. Indeed, the price of gold on the LBME and other major metal exchanges is quite low and near the lows recorded in 2020.
Well, this is just the top of the iceberg. In other words, many investors are not ignoring this opportunity. But there is a clear disconnect between the paper market where very little metal actually gets delivered to its buyers and the physical market.
Good examples of this physical demand are central banks' purchases and physical gold buyers in the US rushing to buy gold bars and coins from licensed shops. Most purchases were made by the central bank of Turkey. I find central banks to be a reliable indicator of what is actually coming. In other words, they surely know the real value of gold and should also know at what price it is the best to buy this yellow metal.
Valuation
I prepared a graph showing the prices of GLD and an ounce of gold in US dollars.
We can clearly see there is a very close correlation between GLD shares and the base commodity. At the same time, the graph above also shows both GLD and gold are trading near 3-year lows.
Basic information about GLD
As you can see from the excerpt above, the price of GLD is also near 52-week lows. All this suggests GLD is somewhat undervalued.
At the same time, the expense ratio for the ETF is just 0.40%, whilst the trading volume is very high. All these factors, in my view, are bullish for investors considering to take advantage of the gold prices.
Risks
Buying a stake at GLD is not without its risks. My main concern is the disconnect between the amounts of physical gold and of paper gold. The former is in highly limited supply. Paper gold, meanwhile, is traded in much larger quantities. So, if many investors request their ETF funds to exchange their shares for physical gold, it will be impossible for the fund managers to do so.
However, this situation is not very likely, unless we face a severe recession accompanied by panic and loss of trust in the financial system. GLD has been functioning on the market for a long time. The fees are reasonable, whilst the bid-to-ask spread is insignificant.
What I also find important is the high correlation between the prices for gold and the GLD price.
Conclusion
Gold seems to be an undervalued commodity, whilst a recession is near. The broader market does not see value in this hedge against economic pain but smart money clearly flows in gold. But intelligent investors buy when many people sell. A smart advice seems to be "buy when there is blood on the streets".
For sure, every investment carries risks. Right now my favorite investment instrument is physical gold. But investors unwilling to deal with physical metals might find an ETF to be a much better alternative. GLD and physical gold have a close correlation.
Anna Sokolidou
A research analyst and a freelance writer looking for value investment opportunities. I have several years of investing experience. I am mostly interested in writing about bargain stocks of large companies. My interest is not limited to American companies but extends to firms operating in other countries but listed on US stock exchanges.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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