Neil Young may have crossed an ocean for a heart of gold, but markets haven’t shared his enthusiasm for the precious metal in recent months. 
Since the nominal gold bullion spot price peaked in August 2020, the gold price has fallen by circa 16 per cent to around $1,723 (at the time of writing). Back in July, we wrote: “It is eminently possible that the latest explosive moves higher in precious metals and miners may well prompt some profit taking and a period of consolidation”.
The question that arises is: is this period of consolidation over, and are the gold price and gold miners poised to move higher or to fall further?
It is important, we think, to understand that in the near term the price of gold is impacted primarily by changes to the ‘real’ (inflation adjusted) rate on US government bonds. When ‘real’ rates move higher, gold tends to move lower.
This back-up in real rates (to a massive, positive(!) 0.12 per cent as at 26/02/2021) looks dramatic above, but perhaps this should merely be a reminder that it used to be considered normal to actually receive a real rate of interest in return.
Gold investors might reasonably panic at this point. However, we do not think they should do so. Remember that US Treasuries are the interest rate that matters for the world. Changes in this have seismic impacts on the ability for companies and governments the world over to meet obligations and refinance debt.
As the global debt burden has creaked ever higher, the tolerance for rising costs of service has diminished (however, falling bond yields have meant debt servicing costs are not as onerous as they might otherwise have been). We can see this with the effective cap on the rate on increase in real rates which has been tolerated over the past 20 years
Real rates bottomed out on 9 March 2021 at -1.55 per cent. If real rates merely stay at the 26 February 2021 level of 0.12 per cent, the base effect would amount to a move higher of circa 1.67 per cent; effectively the upper bound of what the world has tolerated in recent years.
Central banks will protect real rates
As the world seeks to recover from the Covid-19 pandemic and the massive recession the global economy endured as a result of policy responses, an effective global ratcheting higher of real interest rates seems untenable to us.
With most governments also likely to run massive fiscal deficits, will there be enough buying demand to offset the increase in supply? We are already seeing the answer from central banks; they will prove to be the backstop. Already the ECB and Bank of Japan have said that they plan to effectively ensure real rates do not rise so far that they choke off the recovery or trigger a wave of defaults.
Ultimately, we expect the Federal Reserve will be forced to accelerate its rate of bond purchases; the point at which this is implicitly understood to begin may be closer than we think too.
This will require massive expansion of the Fed’s balance sheet and, by extension, of the money supply.
In the chart below we can see a comparison of the monthly gold bullion spot price vs US M2 money supply going back to October 1973. In orange, we have the most recent M2 reading (end of January data) with the current gold bullion spot price (circa. $1,723).
When we look at this data, periods where the gold price is below the trendline implied price have seen stronger subsequent 12-month returns than those where it was above.
Source: St Louis Federal Reserve. Past performance is not a reliable guide to future returns
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Median subsequent 12-month returns |
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Gold price above trendline implied price |
-3.28 per cent |
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Gold price below trendline implied price |
6.99 per cent |
Source: St Louis Federal Reserve. Past performance is not a reliable guide to future returns
Gold miners
Perhaps bullion does not reflect this, but do gold miners? For us, the answer remains an emphatic ‘no’.
Multiples look compelling relative to the wider market, balance sheets remain robust, and industry wide all-in sustaining costs are significantly below the current spot gold level. Even if the wider market does not recognise value here, it seems the companies themselves do, with the announcement this week that Newmont is acquiring GT Gold in an all-cash deal at a 38 per cent premium to the previous share price.
Yet supply discipline remains strong across the industry as a whole, and exploration budget discipline has been very resolute.
Trusts such as BlackRock World Mining (BRWM) and Golden Prospect Precious Metals (GPM) remain, in our view, highly compelling for long-term investors.
Callum Stokeld is an investment trust research analyst at Kepler Partners. The views above are his own and should not be taken as investment advice.