5th April 2024
It is common knowledge that gold tends to perform inversely to real (inflation adjusted) yields. The logic is that gold itself does not provide a yield but historically has been a good defender against monetary debasement and inflation. So, when the real yields on offer from inflation linked bonds are low or falling, the opportunity cost of holding gold falls and the value of gold rises.
The gold price has been rising rapidly since the end of September, achieving new all-time highs in multiple currencies – importantly, including the US dollar. So, it would be natural to assume that real yields in the US must have cratered. Looking at the 10-year US real yield, at the end of September 2023 it was hovering around +2.2% and as of Wednesday was at 2%. So, there has been a gentle drop in real yields, but they certainly haven’t come in aggressively and certainly not enough to justify a 25%+ rise in the dollar gold price, technically putting gold into a bull market.
So, what’s going on?
In recent years, central banks have been buying gold in record volumes. One major outcome of Russia’s invasion of Ukraine was the weaponisation of the US dollar, as the US was able to freeze Russia’s access to $300bn in foreign exchange reserves held by the Kremlin. Whilst an extreme scenario, it woke other global central banks up to the possibility that the US dollar may not always retain its status as the safe-haven, global medium of exchange. Gold, as it has done for thousands of years, can provide this function. Central banks’ motivations for buying gold are not about the yield available on TIPS; rather, they are diversifying their reserves into a store of a value that can substitute for the US dollar. In addition, the US fiscal situation remains poor. Gold carries no counterparty risk, and this additional benefit of gold over USD has driven increased interest by central banks, fuelling the recent rally further.
Demand for physical gold also tends to be seasonal. Strong seasonal demand occurs during the lead up to Christmas, Chinese New Year, and traditional wedding season in India, which falls between November and February, and has further helped underpin the rally. Although, despite moving out of the seasonally strong period, the gold price has continued to rally. Sadly, we have also seen a rise in global conflicts. Gold is seen as the ultimate store of value and a way to protect your wealth during times of heightened instability which will also be contributing to its recent performance.
While the gold price has been making new all-time highs, gold miners have lagged. Part of the reason behind this is a growing East vs West divide. There are different constituencies of buyers between physical gold (central banks, institutions, and consumers in the East) and buyers of gold mining stocks (typically Western investors). Due to the strong performance of global equities (notably US equities) in recent years, the rise of passive investing, and the tiny representation gold miners have in global indices, demand for gold mining stocks from Western investors has been low. Gold miners bring added complications vs physical gold and require significantly more analysis and due diligence. There is also an argument that this riskier role can instead be filled by new assets like Bitcoin. Historically, gold miners have reacted with a lag to the gold price in bull markets for gold. But, when they do react, they do so aggressively. Examples include 20/11/2008 to 29/12/2010 when WisdomTree Physical Gold rose 87% in USD terms and Ninety One Global Gold rose 254% (A Acc USD); from 11/09/2015 to 15/08/2016 gold rose 21%, whilst Ninety One rose 129% (A Acc USD); and from 18/03/2020 to 05/08/2020 when gold rose 37% vs Ninety One +99%. So far, since the end of September, gold is up 22%, but Ninety One Global Gold is up just 18%.
Gold mining valuations are very depressed relative to the gold price, and relative to their long-term history. Should Western investors start to take more interest in the gold complex, there is scope for gold miners to catch up and provide the kind of explosive performance seen in prior bull markets for precious metals.
Dan Cartridge – Fund Manager
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