I’ve had several people ask me lately about gold and gold stocks. It is an interesting topic, for sure. Since my book Choose Stocks Wisely is about stocks, today’s post will speak of the gold commodity (which is an investment itself aside from gold stocks) only as it relates to gold common stocks. Gold closed Friday at $1,324/oz. Many gold stocks are presently trading well below their stock prices sported not all that far back when gold prices per ounce were well below the $1300s.
Pondering the current overall economy and market in light of today’s gold stock prices, it seems that gold stocks may well be out of favor at a time when the broad markets, especially technology, are going gangbusters. This seems reasonable in my view since gold is considered a safe haven and people are feeling pretty confident. Next, it seems gold stocks are out of favor at a time when gold is showing some relative stability and mild strength. This seems somewhat peculiar to me as better gold prices mean higher revenues for gold mining companies. Finally, it seems gold stocks are out of favor at a time when the buzzword of concern in our current economic expansion is “inflation.” This also seems odd since gold is considered a hedge against inflation.
It’s true that recent inflation measures are not showing any major spikes in actual inflation but yet the Fed is looking to raise interest rates three or four times over the year, according to what you hear and read today. This implies anticipation of inflation ahead.
So, I looked at some gold stocks and several indeed looked pretty inexpensive relative to financial positions, without regard to outlook. And if the outlook does bear out any move up in inflation, that implies a potential for growth in earnings of the mining sector. Earnings drive attention to companies and thereby drive their share prices.
As somewhat an aside, yet potentially related, the rise in crypto mania (very recently pulled back in face of regulatory talk) has not at all been paralleled by any similar favor toward gold or gold stocks. If bitcoin, for example, is to act as some kind of digital alternative to currency, is this attraction all about convenience or privacy of transaction; or is it reflective of a more general sense of insecurity toward our present form of fiat money (paper money) itself? If it’s the latter, it seems odd that gold and silver prices haven’t participated in the action.
I share this today only as a potential topic of interest based on some questions I’ve received of late in my local circle of family and friends. With most everything flying high in the stock market, I can understand why some would be thinking at this time about gold stocks.
My final thoughts are that gold stocks have a general reputation of a boring investment; and across history, that reputation is borne out. As I’ve written before about commodity stocks, the performance of the stock is dependent on the performance of the commodity it’s associated with; and predicting with any degree of accuracy what’s next for most commodities is virtually impossible. You know the commodity will go through up cycles and down cycles but you never know when shifts occur and for how long. With commodities, I’ve observed there can be crazy booms and busts. Just look at oil over recent years.
Wrapping up, I suppose if I gave any consideration to gold stocks, I’d sure want to limit it to a time when they seemed out of favor in light of factors that create a market for gold. And the balance sheet strength would remain the hard standard for passing investment muster. Personally, due to past lessons, I’m not inclined to heavily invest in commodity stocks because outlook drives a company’s future operating performance and the outlook for commodities can be very erratic and hard to judge in my view.
I’d welcome you offering your thoughts.
See you next time, friends.
Dr. Allen,
Thank you for the invitation to offer some thoughts because I have some on this subject. I am likely more technically oriented than most of your readers, but as you know I thoroughly enjoyed your book and I always value your posts. I will briefly summarize my thoughts (thesis), and then post some screenshots of charts that support my supposition.
1. My thoughts on this are that investors are not yet convinced that inflation is a serious threat over the next decade, and the US Dollar will have to weaken against the Japanese Yen before gold trades substantially higher.
2. The 5 year breakeven inflation expectation is currently 2.08%, and the 10 year breakeven expectation is 2.11%.
3. Inflation has increased over the last two years: in Feb. 2016 the 10 year breakeven was 1.21% and now 26 months later it is 2.11% (a 74% increase over two years).
4. From June 2003 until May 2004 the 10 year breakeven moved from 1.57% to 2.70% (a 71% increase over 11 months). Here is a chart of the 10 year breakeven https://www.screencast.com/t/01PRV5DJHWH
5. Even though the expectation of inflation had increased substantially by May 2004, gold which had been moving up steadily for about four years did not begin a strong move up until October of 2005. Here is a monthly chart of the gold futures beginning in 1999 and up to the present day. Gold moved strongly from 2005 until 2008 when it had a 27% decline (half that of the equities markets). Then it climbed rapidly until 2011 (likely spurred on by fears of deflation). It then pulled back 50%, and stopped going down in early 2016. Since then it has retraced 38% of the decline from 2011 until 2016, and seems “stuck” at that 38% retracement level. Here is a monthly chart of the gold futures contract: https://www.screencast.com/t/xAsyXY0W
6. The US dollar’s relationship to the Japanese Yen (USD/JPY) seems to be a good tell on how gold will trade. When the dollar is weak against the yen gold has performed well in the recent past. Here is a weekly chart back to 2009 that shows how they seem to mirror each other: https://www.screencast.com/t/KB3pypeUSVO
To summarize, I don’t think inflation expectations have yet spooked the broader market so mining stocks are not leading a move up, and the dollar is still relatively strong against the yen which seems to keep an upward move in the bullion in check.
Thanks for your indulgence,
Julian
Julian,
That is very helpful information! I plan to go back over it again right away. Thank you for sharing it with the blog so others can benefit.
Hope you are well,
Paul