After six months of gold holding a tight range, rarely breaking more than $50 (£36.73) per ounce away from the $1800/oz level that it has maintained, investors could be forgiven for losing faith, looking elsewhere for a bit more excitement, or simply giving up.
Gold miners are trading at some of the lowest multiples vs spot gold they ever have, showing the general apathy to the space.
That six months of low volatility really doesn’t tell the story of what would normally be viewed as powerful forces for this precious metal.
A tug of war between a number of factors appears to have neutralised each other, with what has always been a sentiment metal, leaving many commentators confounded.
The volatility in gold looks likely to pick up when it does finally break this tight range, leaving the question of whether that move is up or down.
The bears will start by pointing to higher interest rate expectations, whilst flagging that gold normally underperforms in rate hiking periods.
I would question whether the perceived opportunity cost of holding gold is that impacted when real rates (net of inflation) go from negative to less negative, whilst at the same time those same rate hikes risk upsetting the valuations of all asset classes via the discount rate.
Is this a normal rate hiking environment?
The potential for policy error feels much greater as the market is weaned off 14 years of cheap financing. It is true rates are going up, but realistically how high can they go before serious pain is felt? Especially amongst an already strained consumer given the inflationary backdrop. Arguably inflation may run much hotter than rates can offset.
A key reason for this is the energy transition and resultant inflationary pressures, with price increases in the likes of energy due to supply constraints.
Gold bears will also flag that known physical exchange-traded fund (ETF) holdings are much higher than they were five years ago. Although this is the case for ETF assets in general, which have grown rapidly over the past decade, physical gold ETFs offer investors a cost-efficient way of owning physical gold.
ETF holdings have shown themselves to be stickier of late, increasing since mid-January, whilst the current uncertain global backdrop provides many reasons for gold ETF holdings to increase. This can have an outsized impact on pricing if the ETF’s shift from steady selling to buying.
Other bears will cite crypto currency as digital gold, claiming that it will cannibalise gold demand. Clearly cryptocurrencies such as Bitcoin offer something very different, both by being highly volatile and a tool for capital creation rather than capital protection.
Gold has a six-thousand-year history of being a store of value and remains a primary diversifier from the US dollar for central banks. This is especially relevant for emerging markets since the US has weaponised the US dollar via sanctions. Notably significant for China, Russia, Turkey, Iran etc.
So, as the most sentiment-driven of all the metals, what will change?
Inflation concerns and the shortage of means of gaining protection looks to be a probable driver. The recent break from the tight correlation with interest rate expectations suggests a shift in flows and why many bearish commentators have been proved wrong recently.
Commodities perform well in inflationary environments, but gold especially excels in stagflationary environments, making it a good hedge against policy error on the global rate hike cycle, should global growth slow as a result.
The miners are attractively valued, trading at or near record low earnings multiples. This is a good gold price, generating strong returns for most producers, so valuations are more suggestive of expectations of a fall in the spot price.
Mining equities have drifted lower in the malaise and offer good returns relative to the general mining sector and market overall. Balance sheets are very strong, supporting M&A, as larger producers look to offset declining reserves and may even look to growth.
Gold miners are exposed to inflationary pressures on input costs such as energy, labour and ever tighter environmental regulation, but this only adds value to existing mines versus new construction.
Could gold go lower?
Well yes, as a sentiment-driven commodity it is harder to call than commodities that are consumed and can be analysed via supply/demand models. But given the negative outlook the market is pricing in, it doesn’t seem the reasons gold could go higher are being given enough credit in current valuations.
Investors should ask themselves two key questions. Firstly, how comfortable they are against this backdrop? Secondly, can gold help protect them from inflationary and central bank policy risk? We believe an allocation to gold makes a lot of sense.
Rob Crayfourd is a portfolio manager at New City Investment Managers. The views expressed above are his own and should not be taken as investment advice.