Strategy Shares, the Huntington, New York-based family of ETFs, recently rolled out the Strategy Shares Gold-Hedged Bond ETF (GOLY), offering investors the potential to generate income from a portfolio of investment-grade corporate bonds while hedging against inflation with a 100% gold overlay.

Traded over the Chicago Board Options Exchange (CBOE), this innovative ETF ties to the performance of the Solactive Gold-Backed Bond Index.

Senior Portfolio Manager David Miller spoke with financial journalist Andrew Bloomenthal about the investment philosophy behind this offering, explaining the long-term potential benefits to investors.

ANDREW BLOOMENTHAL: Let’s begin by dissecting the fundamental principles behind the Strategy Shares Gold-Hedged Bond ETF (GOLY).
DAVID MILLER: GOLY invests in a portfolio of investment-grade corporate bonds that seeks to pay out a distribution of approximately 3.5%, which seems sufficient at first glance, but is actually problematic as a stand-alone component when you consider that the Consumer Price Index1 (CPI) over the past year has increased by 7.99% since 6/30/2020, which means your real yield is effectively -5.5%. One method of solving the dilemma of inflation eating into the principal is to simultaneously invest in the one hard asset class capable of keeping pace with inflation: gold. Consequently, GOLY hedges the bond portfolio 100% to the price of gold, so its value fluctuates with gold prices rather than the bond’s principal.

AB: Did the idea for GOLY come to you suddenly, or did it develop slowly over time?
DM: Both. I’ve consistently wondered why anyone would invest in a bond portfolio if the yield’s eaten away by inflation, but this wasn’t an acute knock-you-over-the-head issue for me. But the idea kicked into high gear in March of 2020, when Minneapolis Federal Reserve Chairman Neel Kashkari went on 60 Minutes and said, “There is an infinite amount of cash in the Federal Reserve. We will do whatever we need to do to make sure there’s enough cash in the banking system.”

This comment was noteworthy because Fed chairs rarely make such blatant public statements. But in doing so, Kashkari conceptually let the cat out of the bag. Sure, we always knew in theory that the Fed could print money out of thin air, but that TV appearance made it clear it has no qualms about actually doing it. And this creates an obvious problem. Because if you have a $100 bill in your pocket, you’d justifiably think it has a certain value attached to it because there’s only a finite number of other $100 bills in the world, where your $100 bill would be divided by the $15 trillion currently in circulation. But if the Fed suddenly announces that the denominator is now infinity, you’d begin doubting the US government’s ability to guard your nest egg, which can no longer be denominated in US dollars.

Contrarily, there’s currently only enough mined gold in the world to fill three Olympic-sized swimming pools, so its supply is far from unlimited, which has been gold’s inherent value for thousands of years. So, gold is clearly the solution, in the sense that it is sound money.

AB: Can you discuss how Solactive, the German index house, created an index specifically for GOLY?
DM: Solactive created the Solactive Gold-Backed Bond Index. The concept was to replicate bonds known as “sovereign gold bonds,” which are issued by the Indian Central Bank. But people aren’t exceptionally comfortable tying their net worth up in the Indian government’s bonds because they’d much rather invest in big companies they know and trust. So, Solactive’s index replicates the concept of gold bonds but comprises investment-grade corporate bonds from well-known blue-chip companies of the world.

AB: Are you concerned about inflation leveling off?
DM: No. Because you need to understand the broad pattern of M2, which is the governmental money supply pushed into circulation. If we look back to 1960, there was approximately $312 billion in the M2 money supply. By 1970, that figure jumped to approximately $627 billion, and by August of 2000, it spiked to $4.8 trillion. Today, it’s over $20 trillion. So, overall, the money supply has been increasing on average by 3% annually. Meanwhile, the price of gold has increased roughly 550% over the last 20 years. I’m not saying gold has to grow another 550% during the next 20 years to be a worthwhile inflation hedge in a bond portfolio, but as long as gold outpaces inflation, it’s done its job. And I believe it will continue to do so because there hasn’t been a time in recent memory where the dollar outperformed gold over a long cycle.

AB: Can investors benefit from gold’s ability to maintain purchasing power?
DM: I believe so. Those people who don’t view gold as a source of capital appreciation may be surprised to learn that the price of gold grew from $283 in January of 2000 versus approximately $1800 today. Comparatively, the S&P is up just a few hundred percent for that same period. It’s an interesting observation because people think stocks had this amazing run, but in reality, they haven’t even kept pace with gold’s purchasing power.

AB: Finally, for what type of investor is GOLY ideally suited?
DM: Some may feel GOLY can most benefit retirees, middle-aged individuals, and any other investor who’s currently parking their money in cash, CDs, short-term bonds, T-bills, or commercial paper. Because even if your investment earns 3.2%, with 5% inflation, you’re effectively left with a -1.8% yield. So, GOLY is really for anybody trying to keep their money in a relatively liquid form who doesn’t want inflation potentially eating away at the principal.

Chart: Gold Price in US Dollars % Change

Source: YCharts