ETF Edge - Gold vs. Bitcoin & Gold ETFs

Episode Date: November 8, 2021

CNBC's Bob Pisani spoke with George Milling-Stanley, chief gold strategist at State Street’s SPDR ETFs, and GraniteShares founder and CEO Will Rhind to break down the divergence between gold and bitcoin this year and global gold demand. In the 'Markets 102' portion of the podcast, Bob continues the conversation with Will Rhind to discuss Graniteshares XOUT ETF Strategy. Hosted by Simplecast, an AdsWizz company. See https://pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge to the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis. We're breaking down what it all means for investors. I'm your host, Bob Pisani. Today on the show, we'll dive into the gold trade.

Even as more investors are calling Bitcoin the new digital gold, we'll speak to one of the world's leading. on gold about why the precious metal still has plenty of power and whether it can regain its luster heading into the new year. Here's my conversation with Will Rine. He's the founder and CEO of Granite shares along with George Mill and Stanley, the head of gold strategy at State Street Global Advisers. George, I know gold is considered a hedge against inflation, but if that's the case, tell me why gold isn't higher this year. People have been asking me this. We're now seeing notable inflation, but gold is down this year and about where it was 10 years ago. Bob, I think that the truth about gold's relationship with inflation needs to be kind of carefully phrased here.

Gold is a very good preserver of purchasing power during periods of sustained high inflation, such as we had during the 1970s, for example. What we have right now, you know, when inflation has been above 5% a year for a period of months or years, as it was in the 70s, then gold has given new capital appreciation equivalent. to 16% a year. So a real rate of return of better than 10%. That's really pretty good for an asset that doesn't have a yield. What we have right now, we've had inflation around 5% for three or four months. And everybody in authority, Mr. Powell, Mrs. Yellen, all telling us that it's transitory, it's not going to last.

So I'm not at all surprised that gold has not responded more to the inflationary numbers we're seeing right now. We'd need those numbers for a lot longer period before we get a lot of. meaningful responses in the gold press. And Will, can you follow up on that a bit? It is impossible gold is also bought for reasons other than inflation. You know, there's all sorts of reasons to buy gold at this point, not just inflation, right? Yeah, that's absolutely right.

I mean, there are a number of ways and number of reasons to buy gold. But just to riff off of, you know, what George just said, I think, you know, put simply, the market doesn't believe we have an inflation problem at the moment. And I think you're only going to see a big response from gold at the point where we acknowledge there is a problem with inflation. And at that point, then the list of places to hide, so to speak, will not be very large. And gold is certainly going to be one of those places that people go to.

But I think at the moment, the reason why gold isn't materially higher, despite the fact that we have high inflation numbers, the highest numbers that we've got since the 70s, is the fact that we don't have a problem in the official eyes of the Federal Reserve and other market comitiers. That is the reason why we can still have stock markets at all-time highs. Yeah, you know, Will, I want to pick up in this digital gold idea. It's commonly said Bitcoin is digital gold. But is it or is that just some phrase that we've all adopted now and sort of half believe?

Is it really a threat to gold? And is there any evidence that Bitcoin is taking? or siphoning investment dollars away from gold? It's really difficult to say, to your point about the evidence of that. I mean, for sure, of course, with the market cap of Bitcoin and other cryptocurrencies, absolutely they are attracting capital. They're attracting lots of capital. To the extent that they're attracting capital away from the gold market, though, I don't know.

I'm sure there's some of that going on, but I don't think it's perhaps as big as some of the commentators might say. to me, it's two very different states. The reason why people are buying Bitcoin and cryptocurrencies at the moment is highly speculative. That's a complete risk-on situation. And you can see that where you have the big drops, obviously in those cryptocurrencies, volatility spikes. It's less defensive in my mind. The reason why people are buying gold at this point is much more defensive. It's around the inflation story.

It's around the long-term preservation of capital. and purchasing power. And to me, those are just fundamentally different states right now. Yeah. You know, George, I think, you know, he's on to something, Will, here. I mean, gold is bought to reduce risk, isn't it? I mean, it seems like crypto is a big risk. Crypto is how many times more volatile than gold is,

five, six, seven, eight times. In terms of volatility, it's a completely different asset class, right? Completely different. I think Will's put his finger on part of the big difference here between the two. And the reason why, I think it is quite possible for these two assets to coexist quite happily in the market, because they do completely different jobs. If you think about it, the contribution that cryptocurrencies, just to finish your question,

we've had Bitcoin for about 12 years, and over that period it has been almost 10 times more volatile than gold. And you and I have both heard over the years people complaining that gold's a volatile asset, well, cryptos are much more volatile. But the contribution that crypto's make to portfolio performance is entirely based on their returns. And as we all know, returns can be positive, which is wonderful, or they can be negative, which isn't so good. The historical promise of gold to investors has always been twofold. One that over the long term, and I stress this, over the long term, gold can improve your returns, and it can also help to reduce your volatility.

Cryptos, as I say, are increasing the volatility. So gold can actually make a contribution toward improving the sharp ratio of a portfolio, which obviously has to be the holy grail of any asset allocator in the world. Yeah, and the sharp ratio, of course, is how well that asset or that stock or asset does compared to the overall market. George, bring this up the global... Does it improve your risk-adjusted returns far? Right, risk-adjusting. Thank you.

Yes, risk-adjust is correct. George, bring this up to date on global gold demand. Now, I mean, we always think of gold as jewelry, and I guess about half of gold demand worldwide as jewelry. Gold jewelry demand, I know, slipped last year in the U.S.'s biggest markets in India and Turkey and China. Has it recovered at all? Yeah, look, jewelry demand typically is anywhere from a half to two-thirds of final consumption

in what I would describe as a typical year. 2020 with COVID, obviously not a typical year. Lockdown, social distancing, all of the issues there meant that gold jewelry consumption fell to about a third of the total when it would more normally have been something closer to two-thirds. We saw the beginning of a recovery in the Q4 statistics for 2020. That recovery has continued. Consumer demand, led by gold jewelry, mostly going into the emerging markets, has done very, very

well in the first three quarters of this year. And of course, we're just coming into, we had Diwali just last week, we're just coming into the big festival season in India, the wedding season in India. For the next six months, that is typically the seasonally strongest period for gold demand in India. Looking at the rest of the world where the Chinese are gearing up for Chinese New Year, not just in mainland China, but in Chinese communities all across Asia and all across the world. And in the West, we're looking forward to Christmas and to New Year, which are also giving again. So I think we should be running into what is typically the strongest period for gold demand in terms of jewelry in the year for the next five to six months. And I think that's part of the reason why gold is where it is today, comfortably above that $1,800 level, which it's found very difficult to surmount during the summer and into the fall. But here we are, wintertime. Gold's doing very, very well.

I wonder if we could put that full screen back up there because, Will, what I found very interesting, and we've been looking at these. for a long time, where the gold is, but only about 15% of the gold supply is held by individuals. We think of people who've got gold bars, or gold coins, or even ETFs, which would include that, and individuals are only about 15% of that. Most of the gold in the world is either in the form of jewelry or in central bank reserves. I always think that's an important thing to remind people about when they think the ETFs rule the world in terms of gold supply. They don't. Yeah, no, that's absolutely right.

But the investor is an important marginal buyer. And so the level of central bank buying has been relatively constant for some time, as indeed has the demand from the jewelry sector. And so that sort of swing amounts, if you will, is very much, I think, relevant to the investor. And so in times where you get a lot of investment demand for gold, that does have an important sway, I think, in factor in terms of the gold price. So I think I always view the investor,

like the important marginal buyer here. Yeah, and I think what you're saying is not only as the important marginal buyer, he actually largely sets the price. It's the gold futures, of course, that really helps set the price of gold, and it's those kinds of people who are involved in the futures market and buying things like the ETF that helps set the price. So you're right, they're the price setters. Now, will you run the Granite shares, gold shares, ETF,

which also holds physical gold like Georgia's GLD? What's your outlook for gold for next year? Well, I'm very positive on the outlook for gold for next year. And the reason is because of what's going on with the macro environment, particularly inflation, you know, I think that the fact that we've held in around this 1800 level, we obviously had the tapering announcement last week, and those that expected the gold price to fall were surprised when it actually mounted a fairly significant rally. And I think that's, in a way, due to this still, you know, the dovishness coming out of,

of central banks, obviously here in the United States, also in the UK, where there was an expectation by some that rates would rise. So policy remains doveish. And then inflation numbers, I don't think that these inflation numbers are as transitory as some might think in the market. I think the supply chain issues that we have around the world

are not gonna resolve themselves as quickly as some might think. And we have real inflationary pressures, that if they persist for, you know, long, or the longer they persist, the more of a problem problem that causes and the more people will look for inflation hedges, and there just aren't that many places to hide. And gold is one of those places that people have always gone to in times of stress. And I think that that is a reason for still believing that gold is going to be there next

year if there's an inflation, an official acknowledgement that, you know, inflation is a problem. And, you know, Will, I always, whenever I do a segment on gold, I always like to remind the viewers that like all physical gold funds, all physical funds, gold is considered a collectible for tax purposes. And could you just summarize a teaching moment here? What should investors be aware of in terms of the tax consequences of gold? Yeah, that's a great question. So with a lot of ETFs, I think there's potentially a common misconception that every single ETF is taxed the same. Of course, the tax treatment of an ETF is largely based upon the underlying asset.

that the ETF owns. So in the case of gold, that's viewed as a collectible, and a collectible attracts a higher rate of tax. It's 28% as opposed to, say, stocks or bonds, which are targeted at the long-term capital gain rate, which at the moment is quite a bit cheaper, but maybe about to go up to see. But it's important.

I think the history around that is potentially if the IRS thinks you're wealthy enough to own gold or other assets like that, you can maybe pay a bit more tax. But apart from that, it's something to bear in mind. Yeah. You know, George, the 17th anniversary of the launch of the GLD, which was the first real gold ETF, is coming up.

It's November 18th, I believe. So that'll be the 17th anniversary. I remember this date very well because I wanted to have you on with me at the New York Stock Exchange, and I remember you declining because you were concerned that the SEC might object. any comments about it. I wonder we could run this bite of that data and be bringing those gold bars because you were very helpful with those bringing those gold bars onto the floor with me. Let's see if we can run that bite for a moment. Today we're going to talk about something totally different. I'm going to talk about this. This is gold. This is a gold bullion bar here. It's 25 pounds. It's worth about $180,000. And I've got three of them here along with a lot smaller amounts of gold, as well as these two burly guards I've been married to for the last half hour. Thank you guys. Why am I talking about gold today?

Because finally, a gold ETF is available. Today, for the first time, thanks to the world, gold counsel and State Street, you were able to buy gold just like it's a stock. And that was November 17, 2004, about 25 feet away. And George, I wish you were there, but you were there in spirit. You helped me get those gold bars on the floor, and I thank you for it. But what a monster it has become in the last 17. years, the GLV?

It's been an unbelievable ride. I'm amazed at how you don't seem to have changed a bit, Bob, in that 17 years, I have to say. I think I may look a little older than I did then, but that's just the game. If you remember, when you wanted me to

come on your show was before we actually had SEC approval to launch. And that was the period when the SEC, of course, insists that we don't say anything to the general public about in ETF until the day that it actually launches and starts trading. That was why I had no choice but to turn you down, although it grieved me desperately to do so. You're an old friend, and I want to keep your friendship.

But the moment that I was back in the country, I was traveling back from meetings with investors in Switzerland on the day of the actual launch, and I was on your show just as quickly as the SEC allowed me to be so, which was a matter of weeks after that particular time. You looked really comfortable holding those gold bars, I have to say. And I think it was a great way to open your show. Show people the product. There's nothing quite so bright and shiny as a brand new gold bar. Yeah. Well, not only that, but during that period, ETFs were still in the infancy, and it was very important for people to understand that you actually owned something, that you owned this underlying, You own stocks that were underlying when you bought BS&P 500.

You actually owned physical gold in this case. This was not a gold futures contract. And today we sort of take it, we talk about spot Bitcoin and Bitcoin futures, ETFs, and everybody kind of understands that. Back then, that wasn't so obvious. ETFs were still very much in its infancy. And I'm very proud we were able to make a big deal about that in the beginning and play a part in educating people about,

not about the revolution of exchange traded funds. That's why I have this show, because I believe so much in what ETFs are doing and the power of the ETF structure overall. You know, George, one of the complaints about gold is it doesn't generate any income. It just sits there. But there was a new fund out just recently. The people behind the U.S. oil fund are old friends over there. They just launched the USCF, a United States Commodity Fund, Gold Strategy,

plus income fund. Now, this owns gold, but it also adds a dividend to it, a dividend component, by selling gold call options and then collecting collateral interest income on this. George, and Will too, can you comment on this? Now you get people who are trying to get a little kicker into your ownership of gold. Yeah, Bob, when I was at the World Gold Council, We were doing our research on GLD back in the year 2000 until we launched in 2004. And one of the things people said to us, the three things they wanted. A product had to be as closer proxy as possible for the physical price of gold, the spot price. It had to be traded on a regulated exchange, preferably the NYAC, where it lists.

And it also had to be 100% secure. If you're writing call options against something, there is always the possibility that a rise in price, might mean that you are called away and you no longer own your underlying. So I think that this new ETF would not fit the criteria that investors told us they insisted on when we put GLD together back in the early 2000. That's really the deal here. That's a very good point. Will, are people deviating from the idea or does this make sense in a modern way,

as long as people understand what exactly George was talking about there? Yeah, I think it's something that, you know, people have always asked for gold with income. You know, it's been, you know, because obviously the answer that doesn't have income. But I think, as George said, it's important to stress that the reason why it doesn't have any income is because gold doesn't have any counterparty or credit risk. The moment you lend gold out, you can introduce an income component, but then you're introducing credit risk or counterparty risk is something that gold investors feel very strongly about. What I've always said is if you want to generate income, there are plenty of good ways to generate income, and if you want to have an asset of the highest quality free from credit and counterparty risk, that's the role that gold plays.

Yeah, good point. One of the beauties, Bob, of GLD is that there's a very, very deep and liquid options market in GLD. If people want to use options, then they can happily do so themselves. They can generate income by writing calls, knowing that the calls could be covered by their underlying holdings of GLD. And that's really the only ETF that can make that claim. Yeah. Well,

let me get, I just want to switch topics just a little bit. I want to get your thoughts on commodities in general because you run the Granite shares Bloomberg commodity strategy ETF. That's COMB is the comb is the symbol. It owns futures contracts on 24 different commodities.

It's been underperforming for years, but commodities are hot this year. You're outperforming. You want to give a broad view of the commodity market right now for us? Yeah, that's right. So one of the first years where, you know, commodity markets is a whole of outperform the stock market at large, you know, quite considerably. And so typically, you know, when you get commodities outperforming to such a degree,

you've got to ask yourself what's going on. And, you know, again, we've talked about some of the issues already on this show. But broadly speaking, you know, this is about years of lack of investment in capital expenditure throughout the entire commodity complex, whether you're talking about the energy complex, whether you're talking about industrial metals or even precious metals. We've had a lack of spending on production, and this is now really combined with this perfect storm of lockdowns capacity constraints last year, breaking into now a global economy that's reopening and, you know, demand, frankly,

outstripping supply for the majority of these commodities. So this has really caused this short-term bull market across the board. I think, you know, Iron ore is probably one of the only commodities is actually down this year. But apart from that, you know, there's been a huge amount of interest in the space. Inflation protection from investors is one big part of this. But also people really thinking about longer term, you know, does this mean that commodities are starting a new super cycle, which obviously could go on potentially for a business? number of years here.

Yeah, and I want to point out if we could put that full screen up about the holdings of the commodity ETF, the comb. This goes back to what I call the politics of indexing. You happen to have 40% in energy. This is not an equal-weighted index. So the fact that oil has had such a spectacular move, it's really helped you outperform this year. Had you only had, you know, 14% of what you were in base metals, you had 14% of that was 14%

energy and, you know, precious metals was. 40% you would have done differently. So my point is that a lot of these indexes really do depend on how they are constructed in the particular weightings that are in them, Will. Yeah, no, absolutely. Same with any index. The interesting thing about this particular index, for example, the Bloomberg Commoddicts, is it's one of the most well-diversified indexes out there.

So actually, each individual sector can never be more than a third of the index at rebalance. And so what that means is that it tries to put a cap on sectors so the energy or industrial metals or can't sort of have an outsized weight in the portfolio like some other indexes in the market. So that just keeps it diversified because a lot of investors, the reason they're buying is for diversification purposes. They want to put the portfolio, 10% the portfolio, and they just want to control diversified way to do that. And I think that, you know, COMB, you know, ticks those boxes for those that they're looking to invest. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast. Today we'll be continuing the conversation with Will Rind from Granite Shares.

Will, thanks for staying with us. I wanted to chat with you a little bit about a very interesting fund that you have called the U.S. large-cap ETF, X-Out, is the symbol there. You know, we had Ben Johnson from Morningstar on last week. He had the result of his latest active, passive report. This examines how active managers are doing against their passive indexed competitors. And, of course, as you know, stock pickers aren't doing any better in 2021 than they've done for the last 10 or 15 years. That is, miserably. But you've got this very interesting ETF, this X-out, which rather than try to pick the stock winners,

you exclude the losers. And can you explain how that works and how it's been performing this year? Yeah, no, absolutely. And so to your point, you know, the S&P Speaver report, as it's called, the scorecard for your active managers versus the index showed that yet again, active managers underperformed. 60% of large-cap active managers underperformed. And that was the 11th year in the row.

So we know that focusing on picking winners is extremely difficult to do, and especially over time after fees and taxes. So what Ex-Out does is it tries to flip that paradigm on its head and ask the simple question, well, what if it was easier to identify companies that are at risk of underperforming as opposed to trying to pick winners? So put simply, rather than trying to find the next Google, try and avoid the next Enron. And so it aims to avoid companies at risk of underperforming, and that's largely because, you know, the underperformance exhibited by companies that tends to be some similar traits that you can identify. And, you know, the common characteristics, if you will. And I think lastly, it's a response to the perceived. floor with passive investing just more broadly, that the weakness of any kind of market-based

index is you buy every company in the index, regardless of whether it's a good or a bad company. Yeah. I guess the question is, and I hate to be so simplistic about it, but is this any easier than buying the winners? Is excluding the losers any methodologically easier than buying the winners. I mean, you have, you have, you score the 500 largest equities for seven fundamental criteria, revenue growth, hiring growth, capital deployment, share repurchases, profitability, deposit growth, earning settlement, sentiment, and management performance. And then you score them, and then you exclude some that are below the median quintile, I believe. And I guess the question is, does that make it any easier to, to outperform?

Well, we would say yes, and so far, you know, the fund went live in October 2019, and so far we have 15% roughly of alpha generated against the S&P 500 of the after-fees. And so we clearly say that that's evidence that the strategy is working. It is able to identify companies at risk of underperforming and leave them out. And I think, you know, what's kind of interesting about this is if you think about what's happening just in general around the market, you've got really this disruption, if you want to call it that. But technological disruption, we believe, is one of largest forward-facing risks faced by investors. Now, that's not a traditional factor that you can just put on your Bloomberg terminal or whatever data provider you use and say, well, I want to exclude companies that are at risk of technological disruption. And obviously, the traditional factors, the farmer French factors, none of those address this risk either.

So what Exalt really tries to do is construct a factor for technological disruption, if you will, and try to. identify companies that are not keeping up, that are not developing fast enough, and exclude those. And really, that's what the model is aimed to do. So we have a quantum-mental approach, like you said, the seven criteria. We score every company in the top 500 by market cap, and then eliminate the 250 with the lowest scores. And then the 250 with the highest scores, and that becomes the portfolio for that quarter. And yet, when you do that, and I look at your largest holdings, you have Microsoft at 8%, Apple at 8%, Alphabet 7, Amazon 6, Tesla 4,

I mean, you know, Will, we've got, this is a large, essentially a large-cap growth here. It's a quality screen, I guess you could say, it looks like. And even it's an ESG screen, these tend to show up in all of these. It's amazing how many, these five stocks show up in virtually everything, no matter what you're looking at. Any kind of large cap, any kind of growth, any kind of quality screen, any kind of ESG screen, they show up. Yeah, and again, just think of although that obviously we have to, or although that is the portfolio, you know, again, the methodology here is we're excluding companies as opposed to trying to pick what are good companies to go in.

And so from that perspective, we focus on excluding names and the 250 names that get the lowest score. And so if you look at those which are excluded, new visa for this particular quarter is our largest name that's excluded. But you'll see some financials in there, such as J.P. Morgan Chase, Bank of America, some energy stocks such as Exxon, you know, traditional consumer stocks such as Coca-Cola. There's a broad range, but the important thing with Excel is it's what you don't own as opposed to what you own. Yeah. You mentioned the Fama French model. For those who aren't familiar with this, in the early 1990s, Eugene Fama and Kenneth French published a very influential paper in which they examined whether or not there were certain sectors, or what we call them today, factors of the market that overperform the overall. market over long periods of time. And what they found was that there are two factors that

seem to provide some modest long-term outperformance. One is that small caps tend to outperform big caps, and the other is that value tends to outperform growth. Now, this was over very long periods, as I recall, Will, their study was 1963 to 1990 to stock market, but it has been adopted by many, many people. And yet, if I would have ten years of let's say bought small cap stocks over big cap and value over growth I'd be rather notably underperforming particularly in the last five years do you have any thoughts about whether there is something wrong with the with that particular finding or things have changed or what do you think about all that well

it's a great question and you know put simply that's the reason why we don't use any of these factors because for the most part Bob they don't work and you Obviously, any back test, you know, I've never seen a bad back test with any of these factors. But in real life performance, you know, over the long run, it's just very difficult to isolate one particular thing and say, well, that's the key to greatness. It's just not as simple as that. And so that's why we don't use any of those factors. We stick to fundamentals. And when you look at the performance of X out, now you mentioned, you know, over a particular period, you might say, okay, well, there's a correlation to growth.

well, if there's a correlation to growth or a correlation to value or any other of these traditional factors, it's a pure coincidence. In other words, it's not something that we screen for. And that's, again, it's extremely important because that's not part of what we're trying to do. Yeah, it's a very good point.

All right, I'm going to leave it there, Will. Thank you very much. Will Ryan, of course, an old friend of mine who runs Granite shares and one of the great experts in the world on gold and on commodities. Everybody, thanks very much for joining us on the ETF Edge podcast.

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