Understanding the Gold Market

The gold market is a common topic, but is it that easy to invest in it? How is the price of gold derived? Where can one go to get access to gold investment products? In this episode we explore all of that and more. Brett Manning, Senior Analyst at Briefing.com joins Cassidy Clement to discuss.

Summary – Cents of Security Podcasts Ep. 92

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers, and today I’ll be your host. Our guest is Brett Manning, Senior Analyst at Briefing.com. 

The gold market is a common topic, but is it really that easy to invest in? How is the price derived for gold and its associated products? In this episode, we explore all of that and more. Welcome to the program, Brett. 

Brett Manning 

Hey, good to be here. Thank you very much. 

Cassidy Clement 

So, since it’s your first episode, why don’t you tell the listeners a little bit about your background in the industry and how you got started? 

Brett Manning 

Yeah, sure. I got started a little unconventionally, I would say. In school, I studied evolutionary anthropology and analytic philosophy, and I had no idea of a practical path forward. But I was bartending in St. Louis for a few years, and I just started programming trading systems. I went at it for three or four years, and I feel like it really laid down a foundation where I had a strong understanding of a lot of different markets. 

I had a friend who was working in the industry who saw some of the work I was doing and kind of grandfathered me in a little bit. It turned out to be a really effective turn for me. And ever since, I’ve just been, you know, nose in the charts. 

Cassidy Clement 

Yeah. So, when we’re talking about the gold market today, people are very familiar with what that is—in the sense of gold as the underlying element of most currency, or what currency is backed by. But what exactly are the elements that make up the items within the market? 

I mean, initially—like I said—people might think, “Oh, I’ll go out and—” you can go to Costco nowadays even and get a gold bar. What are the kinds of ways that people might be familiar with the different aspects of the gold market? 

Brett Manning 

Yeah, sure. It starts with the spot price of gold, which is the price of physical gold, and everything kind of builds from there. All of the other instruments you can involve yourself in are really ultimately founded on physical gold. 

You can go buy physical gold, like you said—Costco sells it now—but you’ll find that the pricing is not advantageous, and you’ll probably need to pay something for security. That forms the gold spot market. From there, you derive the gold futures market and options on futures, as well as options on the spot market. So, there are all of these derivative ways of being involved in it. 

I’ve been active in gold probably for about 22 or 23 years, and by far and away, the instrument I’ve interacted with the most is the gold futures market. 

But for longer-term investors, there are also ETFs—very good ETFs. In commodities markets, sometimes the ETFs are somewhat flawed because they hold futures contracts, and with futures, the timing and pricing of expirations can cause some skews in how well the ETFs track the market. 

But the nice thing with gold and silver ETFs—in the most prominent and popular examples—is that they actually hold the physical metal themselves as the basis for their exposure. So, they track the market relatively perfectly. 

Then there are gold mining stocks—you can trade the companies that mine gold. Now, this is not the same thing as gold, because with gold you’re just dealing with the factors that change the price of gold. With mining stocks, you’re dealing with that, as well as the cost of energy—because it’s very energy-intensive to mine. And then you’ve got to understand hedging positions. 

These are ultimately run by human beings—and human beings are bad at market timing. So, oftentimes you’ll end up with all of the gold miners maximally hedged right before the gold market takes off. So, there’s a lot of different factors to understand there. But beyond that, it’s really jewelry and industrial demand. 

Cassidy Clement 

Yeah, there’s a lot of, I guess you could say, early acknowledgment for a lot of people—whether it was learning around the holidays, seeing a bunch of gold jewels or jewelry for sale. Or you start to see things like I mentioned—the Costco element—or maybe you start to hear about them in an ETF or maybe futures. 

But I guess a lot of people might say, “Okay, well, I recognize initially where I’ve heard of gold or gold in the market, but how exactly can I gain exposure through a financial security? Where can I buy these items?” 

Initially, you think about the direct examples, like I said earlier—but what are the ways or areas that people can go to find some of these securities or items? 

Brett Manning 

Well, I mean, in my experience—and everybody’s going to have a different take on this—it’s really up to you, the listener, the individual. I don’t think there’s any need to stock up on physical gold. Again, your pricing on any unit of gold is going to be worse, and you’ll probably have to pay for some kind of security if you want any kind of large exposure. 

But you can imagine scenarios where it would be advantageous to have physical gold—really the sort of worst possible, existential-risk scenarios for society. So, you put on your tinfoil hat a little bit, and you see that in recent years we’ve had pandemics—maybe even pathogens created in a lab, who knows how many are out there—nationalism, invasions… You can kind of get there in your mind if you want to. 

And if that’s what you’re interested in protecting against with a gold investment, then you probably do want bullion. A bullion dealer is just a Google search away—or Costco. You can find pricing plans that allow you to buy over time. But again, your pricing’s going to be worse on a per-unit basis than any other way you do this, and you’ll probably have to pay something for where you store it. Because if you’re imagining these sorts of scenarios, then you just make yourself a target. 

Otherwise, if you’re back in the more normal world, then any serious professional online broker can deal you into the futures market or the ETFs. As I said, I participate mostly in the futures markets, but the ETFs in this space are good—particularly good—because you don’t get cut by those contango curves in the futures market, so you don’t end up tracking poorly. 

And as for the gold miners, ETFs are good as well. But again, it’s important to understand that you’ve got to differentiate between an investment in gold and an investment in gold miners, which have different characteristics. 

Cassidy Clement 

Yeah, there are definitely a few elements to explore for each investment or security item. The main thing I think a lot of people get hung up on—especially when you’re talking about the gold market in a general sense—is how exactly the price is derived. Because it can be different depending on what the item or the security. So how exactly is the price arrived at? Are there certain factors that impact it, or is it kind of operating independently? 

Brett Manning 

This is where I think the gold market is the most interesting—and one of the reasons why I’ve traded it a lot. Being a more technically minded trader, it’s the most interesting from that perspective. 

I mean, you could say the spot price of gold and basic supply and demand is what causes the price of gold to go up or down on any given day or over a period of time, obviously. But that’s not exactly adding much information to what we’re dealing with here. Any of the different instruments we talked about—the supply and demand for those, in theory, has a pass-through effect on the price of gold. So yes, it’s supply and demand—of course it is. 

But what is causing people to drive that supply or drive that demand—besides, like, Indian wedding season? You could say the two big drivers are: one, the risk of some really bad stuff happening, and two, longer-term inflation expectations if they’re well above where they should be. Those are kind of the two standard ways to look at it. 

Then you’ve got different ways to predict when those types of things are happening. Obviously, geopolitical stuff—if there’s an invasion, for example—you’re going to see the price of gold spike. That doesn’t mean civilization is coming to an end, but it’s a precursor with some small probability assigned to it. 

Or let’s say the Fed is forcing an inverted yield curve on interest rates—so you see negative real rates. Negative real rates tend to have a very strong association with gold, because in theory, over time, they should lead to an increase in longer-term inflation expectations. 

So those are the standard answers. But I’m going to say: I don’t really buy any of that anymore. After doing this for so long, I’ve seen enough cycles to know that all of those factors can be lined up in a particular way, and you’ll see one outcome in gold—and then in the next cycle, they’re all lined up the exact same way, and you see the opposite outcome. 

In reality, in my experience, the psychological and technical drivers are the most important factors for gold. It’s very difficult, if you think about it, to make an absolute, fundamentally driven price target for gold. It’s probably more difficult than for any other market—because its actual economic value is much, much lower. 

So, it’s already skating on thin ice. If gold were priced purely based on how it’s consumed in the economy, it might be worth a hundred bucks an ounce. But that’s not what’s happening. It’s the other part—the investment demand—that accounts for the additional few thousand dollars per ounce. 

Just do a thought experiment: say gold were to run 200% higher over the next three months—just take off, without any obvious changes in the world. If it were any other market, you’d see some deep-pocketed investors making a strong fundamental argument that the move is way overdone, and they’d wade in with an infinite amount of money—shorting more and more at higher levels—because they have confidence their target is right. 

But nobody’s going to do that in the gold market. You’re not going to step in front of it, because hey—maybe it’ll go 200% more than that. You really don’t know how to calculate its price target. 

That leads to, in my opinion, one of the most interesting markets to trade, to be involved in, and to engage with—simply because everybody else at the poker table doesn’t understand where it’s going either. You’re not subordinate to institutional players. 

Cassidy Clement 

Right. There are definitely influences on gold and the market, similar to traditional securities—but there’s also this element of market sentiment and supply and demand coming together with a bit of ambiguity. 

This is where we start to get into more traditional securities thinking—like undervalued versus overvalued scenarios. But with everything you mentioned, some people may think, “Okay, there’s definitely risk here, like any other investment—but there’s a lot to consider before jumping in.” 

So, what are some reasons people would want to incorporate gold into their portfolios? The initial thought process might be: holding value, diversification, maybe some liquidity aspects. But why exactly would someone enter this area of investment? What would be the drivers? 

Brett Manning 

I’d say it’s primarily as a hedge against the types of things we just talked about—like sudden escalations of geopolitical tensions. Maybe you reduce exposure once that happens, because very few of those instances follow through. 

If a geopolitical event ends up fomenting a long-term gold bull market, that’s a pretty bad situation—it’s essentially the end of the world, economically. But you still want to be involved for the moments when the stock market drops off a cliff and the gold market takes off—because of some piece of geopolitical news nobody saw coming. 

And otherwise, gold isn’t that volatile—so it’s not really that big of a risk to have some exposure like that. 

Another reason: just look at traditional portfolio theory—and the way institutional investors have treated gold for years. Studies from people like Ray Dalio show that portfolios with some small, consistent exposure to gold tend to outperform others over long time frames. The data is there. 

Cassidy Clement 

Yeah, I think that while gold may not necessarily be seen as a “safe haven,” it definitely has a different kind of investment appeal. But there are still important considerations—like the quality of the asset you’re going after. 

What I mean by that is: does it actually fit the investment goal or time frame you’re working with? And as you said—how quickly might you need it? Is it a dire situation? Hopefully not. 

But there are definitely pros and cons associated with this type of investment. So what exactly would you say are the limitations and strengths of gold investments, since they can be viewed in a few more ways than just a traditional stock? 

Brett Manning 

Yeah, sure. And the difficulty there is simply—as I said—there’s gold this cycle, there was gold last cycle, and there will be gold next cycle. And for all intents and purposes, those are three completely different markets with different characteristics. 

So it’s tough to really understand—except over the very, very long term. We’re constantly going to be expanding our money supply in some way. It’s a stabilizing factor for a portfolio. So I’d say the main pro is typically it’s not very volatile—especially on the downside. There have been moments when it has been in the past, but it’s always going to catch its breath. And gradually, if you look at a monthly chart of gold, it shows you the depreciation of our currency. That’s the picture. 

So you can really think of gold as just a sideways line—and the more dollars we’re creating, the more that disparity grows. When you look at it on a dollar-denominated chart, that’s gold gradually trending to the upside. 

Does it go up as fast as, say, an artificial intelligence stock? No. And so there’s opportunity cost. But it’s a stabilizing element as part of your portfolio. You don’t need every single dollar you have to be in the most aggressive conceivable position. 

And I guess here’s the main pro, given everything I’ve said so far: it’s the one market that is fundamentally uncorrelated with everything else. That can be a really important thing—because when something unexpected happens, correlation goes to one across just about everything else. It’s good to have some money in something that’s not going to move exactly the same as everything else. 

Cassidy Clement 

Yeah, a lot of people tend to view a gold investment as something that can act as a stabilization factor for different advantages—like using it as a potential inflation hedge, or for additional diversification within a portfolio. 

But then, as you mentioned before with actual physical gold, you start to enter into the area of: “Okay, how do I pay to store this item? What are the tax implications if I sell?” There are a lot of elements to take into consideration. 

Which kind of leads me to my final question: if somebody is starting to consider gold as part of their investment strategy—or something they want to get more interested in or learn more about—what are some things to keep in mind if they’re looking to incorporate it into their financial plan? 

Brett Manning 

Well again, I’d go back to that number one quality: it’s probably going to be uncorrelated with most everything else in your portfolio over the long term. 

At any given moment, yes—it’s going to have varying correlations. But if you’re thinking about how you’re positioning yourself in a long-term portfolio, it’s extremely important to have the mindset that you don’t want your holdings to have the potential to go to 100% correlation across the board. 

Otherwise, gold is something to own a bit of—and then basically just forget about. There’s been enough research, over a long enough time, to give you confidence that gold can be a stabilizing factor for your portfolio. Over time, performance is better when you have different forces at play. 

Having an uncorrelated, stabilizing factor that rises when the worst possible news hits? That’s a good thing to have in the mix. 

Cassidy Clement 

Yeah, that’s one of the main reasons people start to get interested in the gold market—seeing how some of this diversification can support overall market performance. 

So thank you so much for joining us today, Brett—you brought up some great points. 

Brett Manning 

Hey, thank you very much for having me. It was a blast. 

Cassidy Clement 

Awesome. As always, listeners can learn more about a wide array of financial topics for free at interactivebrokers.com/campus. Follow us on your favorite podcast network, and feel free to leave us a rating or review. 

Thanks for listening, everyone.