Today I thought I’d update you on our structurally bullish view on gold. We view gold as a currency.
Australian gold producer equities are in effect leveraged call options on a rising Australian Dollar gold price.
It’s a little known fact that the Australian Dollar Gold price hit a fresh all-time high this morning of A$1820oz. Yes, unhedged Australian gold producers are selling gold at record prices, which will lead to strong earnings and dividend growth for Australian gold producers. It will also lead to strong cash generation and debt repayments.
Australian Dollar Gold price: fresh all-time highs
Brexit – a possible contagion starting?
In isolation, Brexit was a political decision to formally exit the EU in which the UK was only a defacto member anyway. The economic positives are a fall in the Pound will support export growth and the current account. In addition, the UK is now free to negotiate and renew trade agreements previously banned with EU membership. The overriding negative is the potential loss of London as Europe’s financial centre. Interestingly we have already seen three major UK commercial property funds freeze redemptions, a move not seen since the GFC.
In an increasingly inter-related world however, it’s not that simple. The bigger problem is the possibility of a Brexit political contagion. A Brexit increases the chances of a EU exodus as other members become disenchanted with a “one size fits all” monetary policy and a lack of political autonomy. The risk is another disorderly fall in the Euro and the extreme financial volatility which characterised the Grexit fears (the Greek sovereign crisis).
Similarly, the strong “remain” vote in Scotland and Ireland will rekindle cessation ambitions increasing the possibility of a UK break-up. Such an event would turn a singularly political issue into a major UK economic problem.
Finally, the Brexit vote is a manifestation of a global rise in nationalist populism and economic inequality. The other risk is the UK’s decision might embolden the pro-Trump groundswell and heighten the tensions surrounding the US Presidential election. Meanwhile, as I keep writing, increased uncertainty and heightened volatility will remain the only constant.
Gold – a new bull market?
Against a backdrop of geopolitical and financial uncertainty, gold has recently enjoyed a resurgence as a safe haven investment. Indeed, legendary investor George Soros and other high profile hedge fund managers have become very vocal in support of gold. While Soros is famous for his short of the UK Pound, he has also publicly voiced concerns over the potential for another EU crisis.
On cue, Brexit has resulted in the GBP/USD falling to its lowest level in 35years sparking fears of a possible EU break up which in turn has supported a 5% surge in gold. Well done again George. You’re still the king.
In 2011, the gold price peaked at an all-time high of $US1895oz. Following a 5 year bear market, and a recent double bottom around $US1090oz, gold has broken upwards through important technical resistance of $US1308oz. To be sure, the UK referendum has supported the recent rally.
At the same time many of gold’s long term fundamentals have turned bullish. Has gold entered a new bull market or is the recent rise just another false breakout within a long term downward trend?
Lunatics and border guards
“Goldbugs” are usually associated with the lunatics who buy cans of baked beans and sit in bomb shelters waiting for the end of the world. John Keynes famously said that gold was a “barbarous relic”. Warren Buffett has always shunned gold while a US Treasury Secretary once described gold as something only needed to bribe border guards.
Despite the scepticism, gold’s performance as an alternate investment is impressive. In the last gold bull market, gold rose 640% from a low of $US256oz in 2001 (to its peak in late 2011). This compares to a 14% rise for the S&P 500 over the same period. A 625% outperformance over the US benchmark equity index is not bad for a barbarous relic! Still sceptical? Maybe a look at the gold/Dow ratio might help change your mind.
Gold divided by Dow Jones – shows golds strong outperformance over equities from 2001 to 2011. Gold would need to double (or the Dow halve) to hit the same multiple as 2011.
Gold’s drivers – a cause of confusion
The consensus view is that gold’s primary driver is a hedge against inflation. This is a popular misconception. As seen in the list below, gold’s drivers are many and varied.
- real interest rates (difference between inflation expectations and nominal interest rate.)
- the trend in credit spreads (US 10 year govt v corporate bonds)
- the steepness of the yield curve ( 10 year and 2 year spread)
- the trend of the US dollar
- faith in the banking system’s solvency
- faith in the central banks
- the relative performance of financial stocks vs. the broad market
- the rate of change in money supply growth
- the trend in commodity prices
Gold fundamentals – shining brightly
As highlighted, gold has many drivers but not all are required to ignite the start of a new bull market for the commodity. At the moment, some of gold’s drivers are beginning to stir.
Clearly, the credibility of central banks is under severe pressure due to the failure of unconventional monetary policy. Similarly, commercial banks are underperforming the broad equity market as negative interest rates threaten to undermine traditional business models and onerous regulations reduce profitability.
In addition, global money supply growth is accelerating and global fiat currencies are being debased due to excessive central bank money creation policies. The Fed has stepped away from raising interest rates. This will further cap the performance of the US dollar, which in the short term has already supported a rally in other US dollar denominated commodities.
At the same time, credit spreads are tightening and yield curves are showing signs of becoming inverted.
While it’s early days, some of gold’s drivers are beginning to shine. The fat lady hasn’t started to sing yet, but she is humming. Meanwhile, heightened volatility through global financial and political uncertainty will continue to support the gold price.
Negative interest rates – a positive for gold
As mentioned above, a popular belief is that gold is bought primarily as an inflation hedge. Over the last 12 months central banks have slashed long term inflation expectations. So it would seem logical that in a deflationary climate, gold should be significantly lower? Wrong.
Inflation or deflation have the same effect but reside at the opposite ends of the spectrum. Inflation through higher prices erodes the purchasing power of money while deflation through falling prices debases the value of money. Negative interest rates are a manifestation of deflation which in turn is being exacerbated by the excessive money creation policies by central banks. The end result is a fall in the value of money.
With negative bond yields, the issue is a return of money rather than a return on money. Unsurprisingly, an investment in gold is becoming more attractive. Importantly, the carry cost of gold is also eliminated with negative real interest rates. This is a really big positive for gold which is often overlooked as it rarely occurs.
Gold – stability within volatility
In a period of extended and heightened volatility, a diversified approach to asset allocation is critical in generating outperformance. Gold shines in periods of political and economic uncertainty. The shiny metal also thrives when the financial system is under threat.
Currently, central bank policy is losing credibility and the business models of global banks are under threat. Geopolitical issues are rising. More importantly, the outlook for global economic growth is deteriorating with deflation, $11.5 trillion of negative bond yields and a trend to yield curve inversion. At the same time, monetary policy has no leverage as a policy stimulus with interest rates at zero or negative.
Gold has experienced some false starts, but the long term fundamentals are aligning. Could this be the start of a new bull market? The last started from $US256 oz., but this time the price is much higher. As a result, the upside could be explosive. In the short term however, gold will be supported by global uncertainty and no carry costs.
The AIM Global High Conviction Fund has all its gold exposure (10% of AUM) through ASX Listed Australian gold stocks. The fund has long positions in Newcrest (NCM), Regis Resources (RRL), Northern Star Resources (NST), and recently added the gold/nickel producer Independence Group (IGO).
The 5-year chart below of the Australian Dollar Gold price and the ASX Gold Index (green line) shows ASX listed gold stocks continue to lag the A$ gold price. We are positioned for this performance gap to close in favour of ASX listed gold stocks.
The AIM Global High Conviction Fund continues to perform solidly in volatile times. The fund remains open to existing and new investors. We are also pleased to announce that this month we are launching a new product that allows access to the fund for retail investors with a minimum investment threshold of $10,000. Please email la@aimfunds.com.au to register.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
