Exchange-traded funds tracking gold and inflation-protected Treasuries provided the best risk-adjusted returns of the biggest ETFs in the past five years as record stimulus by the Federal Reserve sent investors searching for inflation havens.
The BLOOMBERG RISKLESS RETURN RANKING shows the SPDR Gold Trust gained 5.9 percent in the five years ended yesterday when adjusting for price swings, topping the list of the 10 largest exchange-traded funds in the U.S., data compiled by Bloomberg show. iShares Barclays US Treasury Inflation Protected Securities ranks second with a return of 5.8 percent.
“Gold and TIPS are the most liquid way to get exposure to inflation,” said Michael Mullaney, who helps manage $9.5 billion as chief investment officer at Fiduciary Trust in Boston. “The volatility in gold and TIPs will remain low going forward as the ugly head of inflation will emerge, and we will see a steady increase in gold demand.”
The two ETFs beat funds tracking stocks and corporate bonds as 10-year expectations for rising consumer prices jumped to the highest since May 2006, amid three rounds of asset purchases by the Fed and a record federal debt. While a weak labor market has held current inflation in check, Bill Gross, who runs the world’s biggest bond fund, said Oct. 5 the Fed’s open-ended plan to flood the economy with $40 billion a month will stoke inflation.
The Gold ETF Volatility Index has tumbled 32 percent this year, signaling that traders continue to expect the investment won’t be hampered with big swings.
Investors have “to make a bet on reflation or deflation and recognize that the market power currently rests with central banks,” Gross, who manages the $278 billion Total Return Fund at Newport Beach, California-based Pacific Investment Management Co., said in an interview Oct. 5. “We are betting at Pimco on reflation.”
Gross has urged investors to buy TIPS and bonds with short maturities, or real assets such as gold and real estate.
The Fed said last month it would expand holdings of long-term securities with open-ended purchases of mortgage debt a month and keep the benchmark interest rate near zero percent “at least through mid-2015.” The central bank purchased $2.3 trillion in government and housing debt in two rounds of so-called quantitative easing from December 2008 through June 2011.
Ray Dalio, the billionaire investor who runs the world’s largest hedge fund at Bridgewater Associates LP, has called QE3 the “new interest rate,” a reference to the fact that the Fed’s benchmark rate is already near zero and the bank is resorting to asset purchases to market rates lower. All investors should hold some gold in their portfolios, he said.
SPDR Gold Trust had a total return of 134 percent over the past five years, the best among the 10 biggest ETFs, and the third-lowest volatility. The TIPS ETF had the lowest volatility and the third-highest total return. The iShares iBoxx Investment Grade Corporate Bond Fund, second by total return and by volatility, placed third.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
The ranking of the 10 biggest U.S. ETFs by market capitalization includes funds tracking the Standard & Poor’s 500 Index, the Nasdaq Composite Index, emerging-market shares and corporate bonds.
The jump in demand for gold and TIPS has come even while most inflation indicators have remained stagnant. U.S. consumer prices, excluding volatile food and fuel costs, were little changed for a second month in August, Labor Department figures show. Gains in the cost of living are likely to stay near the Fed’s goal of about 2 percent this year and in 2013, according to a Bloomberg survey of 74 economists.
Inflation averaged 2.2 percent over the past five years. Economists in a Bloomberg survey are forecasting that consumer prices will climb 1.9 percent this quarter, accelerating from 1.6 percent in the previous three months, according to the median of 68 estimates.
Investors initially increased their inflation expectations after the Fed announced its plan for a third round of asset purchases. The gap between yields on 10-year notes and same-maturity Treasury Inflation-Protected Securities, or TIPS, widened to 2.73 percentage points on Sept. 17, the highest since May 2006. The so-called break-even rate, which measures how much traders anticipate consumer prices will rise over the life of the debt, has since narrowed to 2.55 percentage points.
Demand to protect against higher long-term bond yields over the next six months has been static since Bernanke announced the third round of quantitative easing, Barclays Plc data show.
Investor gold buying may also slow, according to ABN Amro Bank NV. The bank forecast on Oct. 2 that prices would drop to $1,700 by the end of the year. That would be a decline of 3.7 percent from gold’s close yesterday of $1,765.
While the U.S. labor market helped keep domestic inflation pressure in check, the jobless rate unexpectedly fell to 7.8 percent in September after 43 months of staying above 8 percent. The surprise decline in the U.S. unemployment rate may give President Barack Obama’s re-election campaign a boost a month before the election.
Whoever wins the presidency will contend with a budget on a trajectory characterized as unsustainable by Federal Reserve Chairman Ben Bernanke. The U.S. may tumble into a recession next year if Congress fails to avert the so-called fiscal cliff of automatic spending cuts and tax increases, International Monetary Fund Managing Director Christine Lagarde said in an interview with CBS Oct. 1.
The U.S. faced an impasse over raising the debt ceiling last year until Congress approved a plan to head off a default and Obama signed the legislation on Aug. 2, 2011. The S&P 500 Index slumped 3.9 percent in the month before the deal, and Treasuries returned 2.3 percent, a Bank of America Corp. index shows.
In the month leading to the agreement, the SPDR Gold Trust again placed highest in the riskless return ranking and the TIPs fund was second. The Vanguard U.S. Total Stock Market fund and the SPDR S&P 500 ETF Trust did the worst.
Gold’s rally that began in 2001 is the longest since at least 1920 in London. The SPDR Gold Trust’s 60-day historical volatility has fallen 64 percent from a 22-month high on Oct. 26. Central banks increased their holdings of the metal, and may add close to 500 metric tons this year, according to the London-based World Gold Council.
Investors have piled into gold in the past eight years, hoarding a record 2,582.43 metric tons of the metal in global ETPs as of yesterday, data compiled by Bloomberg show. Holdings have increased every year since the data begins in 2004. U.S. gold-coin sales last month climbed to 68,500 ounces, the highest since January.
The rising demand will probably mean more price gains for the metal. Credit Suisse Group AG on Sept. 28 forecast that gold will reach $1,800 an ounce in three months, and Newmont Mining Corp. Chief Executive Officer said Sept. 26 that the metal will touch $2,500 in three years. Billionaire investor George Soros more than doubled his investment in the SPDR Gold Trust to 884,400 shares as of June 30, compared with three months earlier, the latest government filing showed.
Yields for TIPs maturing in one to 20 years are near record lows, and traders are even paying more than face value to hold the securities. TIPS are typically less volatile than nominal Treasury bonds as changes in so-called real yields, which affect TIPS, are less volatile than changes in nominal yields.
Bond yields have been mostly below the Labor Department’s consumer-price index since April 2011, resulting in negative real yields as investors sought the safety of U.S. government debt. The fixed payment on TIPS, known as the real yield, was pushed below zero on TIPS maturing from one through 20 years as the rise in the CPI was greater than the yield on the notes, which fell with other Treasury yields.
“The Fed has told us that they are more focused on growth than they are on inflation and have hinted that they are willing for inflation to rise even higher,” said Donald Ellenberger, who oversees about $10 billion as co-head of government and mortgage-backed securities at Federated Investors Inc. in Pittsburgh.
Neither Obama nor his Republican challenger, Mitt Romney, “can do much about the fiscal situation in the near term,” said Martin Murenbeeld, the chief economist at Toronto-based DundeeWealth Inc., which manages about C$100 billion ($97 billion) of assets.
“The die is cast in the short run,” Murenbeeld said. “The U.S. economy is not growing rapidly and the accommodative policy will have to continue. The inflation worries will remain, and I see both these investments getting bids.”
The yield gap between 10-year notes and TIPS, a signal of traders’ expectations for inflation, has risen to 2.55 percentage points after touching a 2012 low of 1.9 percentage points on Jan. 3. The gauge will rise as high as 2.6 percent by the end of the year, said Michael Pond, head of global inflation-linked research in New York at Barclays Plc.
“The Fed couldn’t be clearer: they are on hold for a long time and are now venturing into unchartered waters, as inflation expectations have never been this high during any of the previous rounds of QE,” Mihir Worah, who manages Pimco’s $22 billion Commodity Real Return Strategy Fund from Newport Beach, California, said. “They don’t mind higher inflation to drive growth, and as long as that is the situation, and real interest rates stay low, gold and TIPS will continue to benefit.”