Charts of the Month

CHART 1 – GOLD DEFIES THE NAYSAYERS

Aside from crypto, few assets are as polarising as gold bullion.

The gold bugs view it as the ultimate safe-haven asset and a proven hedge against fiat currency debasement. The bears take issue with its lack of yield and limited economic use. Unlike silver, which plays a key role in many industrial processes (including the green energy transition), gold demand is driven predominantly by investors and Central Bank reserves.

We often field questions about why gold doesn’t fare better, but its historic returns typically provide a pleasant surprise.

The chart below shows how well bullion has performed in recent years.

In the five years to end March ’24, gold in US dollar terms (red line) produced an identical gain to the global stock market’s 72% total return (dark blue line). If we strip out the dominant US tech names, gold has comfortably beaten the return of the FTSE World-ex US equity index, which advanced by 41% (in U$) over that period.

More relevant is its gain relative to global government bonds; another perceived safe-haven asset. The light blue line shows the FTSE World Government Bond index nursing an 11% loss over the past 5 years as yields have spiked in response to inflation and fiscal largesse.

Of the major asset classes only Bitcoin has outperformed with a staggering 1,600% total return, although you would have needed to stomach two separate 50%+ pullbacks along the way.

The key question is why are gold, bitcoin and the US tech stocks performing so well?

We believe there are multiple answers, but the common denominator is that their “scarcity value” is coming to the fore. In an era of fiscal dominance, like we are in now, Central Banks are ultimately being forced to fund excessive government debt burdens. This requires more and more money printing which, in turn, increases the appeal of any asset whose supply is growing by less than that of fiat currency.

CHART 2 – DO INTEREST RATES STILL INFLUENCE THE GOLD PRICE?

The gold price has boomed in recent years, but it is no longer trading in lockstep with US interest rates.

Typically there is a marked inverse correlation between gold and bond yields. The reason being is that gold doesn’t generate a yield so when cash and bond rates go up, investors tend to choose those as their favoured safe-haven assets. The converse is also true.

The chart below shows the price of gold bullion (red line) against the 10yr US inflation-adjusted (real) bond yield (blue line) going back 15 years. Importantly, the gold price is inverted so when the red line is declining that reflects the gold price going up and vice versa.

Until early 2022 these lines moved in tandem but, ever since, the gold price has defied the spike in US borrowing costs and rallied to new highs.

It is no coincidence this trend broke down around the time Russia invaded Ukraine. The resulting financial sanctions imposed on Russia included the freezing of around half its U$700bn foreign currency reserves, much of which was invested in overseas government bonds. This was an unprecedented move that has prompted Central Bankers elsewhere, especially in developing markets, to change how they allocate their own reserves. Anecdotal evidence suggests, in aggregate, they are buying fewer US Treasury bonds (historically the preferred exposure) and a lot more gold bullion. 2022 saw 1,082 tonnes of Central Bank gold purchases; a record that was almost matched again in 2023.

Geopolitics is thus playing a key role in gold’s rally, but so too is strong Chinese retail demand, where investors are seeking a hedge against fiat currency debasement. These two factors help explain why the gold price has become detached from US interest rates.

CHART 3 – SILVER SHOULD OUTPERFORM GOLD FROM HERE

It’s a little surprising that silver hasn’t performed better of late.

In the five years to end March ’24, gold has produced a 72% gain in dollar terms, whilst silver is up 65%. That’s still a good outcome, but silver typically outperforms gold (by a lot) during major precious metals bull markets.

On a standalone basis this suggests the rally in precious metals has a lot further to go as we haven’t yet seen the blow-off top in silver that would usually mark the end of a bull market.

The chart below supports this constructive outlook and argues we may be on the cusp of a major move higher in the silver price.

It shows the gold price divided by the silver price. Over the past four decades, whenever this ratio has exceeded 80 it suggests gold is relatively expensive compared to silver, with the latter likely to outperform going forward. When the ratio heads towards 40, the converse is true.

For context, when the ratio hit a record 113 in early 2020, during the nadir of the Covid market sell-off, silver embarked upon a 140% price surge in just six months. Gold gained 40% over the same period. For clarity, the gold price still tends to rally strongly when this ratio falls, but silver typically outperforms.

We do not believe it will experience such an explosive move this time around, but a major bull market in silver is likely just getting started.

The ratio has been trading in a tight range between 80 and 95 for a while now. This means it is more likely to fall than rise from these levels, especially with the global economy witnessing a cyclical upswing. Silver plays a crucial role in various industrial processes helping its price rise (and the gold/silver ratio fall) during periods of accelerating global growth.

CHART 4 – GOLD MINING STOCKS ARE SUPER CHEAP

A major bull market in gold mining stocks began in January 2016 after a brutal 5-year downturn that saw the GDX gold miners ETF shed almost 80% in dollar terms and many of the junior producers go bust.

Since then, GDX has produced an impressive 160% gain in dollar terms, equivalent to almost 13% per annum. This exceeds the returns from both gold bullion and the global stock market over the same period. Despite this, we’re surprised the mining stocks haven’t performed better as they typically have even more upside potential when gold is rallying strongly.

The charts below show valuation is not a hurdle to higher prices which, in turn, suggests the broader bull market in gold and silver equities has further to run.

On a price to book basis, gold mining stocks are trading around just 1.5x (blue line), exactly half the 3x multiple they have averaged since 1980 and well below the 13x late 1980s peak.

Simply put, gold miners are trading at very cheap levels in absolute terms, especially when you factor in their solid (low/no debt) balance sheets, healthy cashflow & dividend yields and improving profits outlook. After its 8% Q1 gain, the gold price is trading around a record U$2,300/oz, which compares to an average all-in cost of production of U$1,350/oz for the gold mining industry.

Gold miner profit margins have seldom been this high and, significantly, they are trading cheaply relative to broader equity markets. Per the second chart (red line), the price/book valuation of gold miners compared to the equivalent for the world stock market is trending towards the lower bounds of a 40yr range.

This begs the question, what could be the catalyst for the next big move higher in gold mining shares? If history is any guide, a wave of M&A activity would be quite normal at this stage of the cycle and that typically sparks a strong market rally, especially in the more speculative, junior mining stocks.

Encouragingly, there are signs that this consolidation trend is underway with the surging gold price encouraging the larger producers to secure future supply growth via mergers and acquisitions.

Watch this space.