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February
13
2019

Gold’s Surge Has Been Disguised by the Strong Dollar
Evie Liu

Gold seems to be out of favor, but that’s only compared to the U.S. dollar. 

Over the past two decades, the commodity has actually seen a widespread, strong, and sustained value appreciation around the globe against 72 currencies, according to Ross Norman, CEO of London-based bullion broker Sharps Pixley. That basket of currencies includes developed countries such as Canada, Australia, and Japan, as well as emerging markets including Brazil, India, and Iran. “Using the dollar gold price, as most of us do, has disguised what is actually quite a powerful bull market,” Norman wrote in a note last week.

Inigo Fraser-Jenkins of Bernstein thinks that this bullish trend could continue. With expensive stock valuations, rising geopolitical tension, and an imbalance in supply and demand, gold could be an attractive investment choice for the decade ahead.

Traditionally, gold–as a safe haven and defensive play–underperforms stocks for most of the cyclical periods. But not all the time. 

Since 1941, when the cyclically adjusted average price-to-earnings ratio of all U.S. stocks is in the historical top quintile, over the next three years, gold and stocks generated similar returns, wrote Fraser-Jenkins in a note on Monday. 

Admittedly, the real return on gold over the past century has been much lower than other risk-free assets such as Treasury bills. But T-bills today may be less safe now, Fraser-Jenkins wrote.

Global government debt has risen to a near-record level since World War II, posing an increasing risk of inflation through additional capital in the market. The U.S., for example, has seen its national debt relative to gross domestic product grow 86% from 2000 to 2017, noted David Kotok of Cumberland Advisors. And that’s not the highest compared to developing countries such as China at 109%, Mexico at 135%, and Iran at 233%.

Geopolitical tensions are also rising, with the U.S. and China locked in a trade war, and the European Union struggling with some members’ financial crisis. Although generally a safe bet, Treasury bills still have a default risk if a government went bankrupt or ceased to exist. 

Demand for gold is rising in both the public and private sector. Monetary demand for gold has overtaken jewelry purchases as a primary growth point in recent years, according to Fraser-Jenkins. Monetary demand includes both private investors looking to hold physical metal, and central banks looking to diversify foreign-exchange holdings.

The end of Bretton Woods system in 1971 saw the U.S. dollar displace gold as the global reserve currency, gold reserves in global central banks tumbled. From 1966 to 2008, the share of central bank gold stocks out of the global stocks has dropped from 45% all the way down to 18%.

The 2008 financial crisis, however, undermined investors’ trust in the U.S. dollar as a safe haven. Since that year, central banks have bought nearly 3,700 metric tons of gold. Fraser-Jenkins believes that if the U.S. share of global GDP continues to decline, this trend is likely to persist in the future. 

As demand goes up, however, gold reserves are shrinking. Lower gold prices–against the U.S. dollar–has led to less capex investment in the industry, hence lower mine production and less new reserves discovered. 

There has been a wave of mergers in the gold-mining space, noted Fraser-Jenkins, driven by companies’ desire to consolidate resources and improve efficiency. Barrick Gold (ticker: GOLD) completed the acquisition of Randgold last month. Newmont Mining (NEM) has agreed to acquire Goldcorp (GG).

Despite that, even if all the projects in the pipeline came on line, the world output of gold likely won’t grow, wrote Fraser-Jenkins in the research. “At current levels of capex and price, gold reserves will continue to be under pressure. Production of gold (depletion) will remain greater than reserve additions.” 

Gold-mining stocks are not as safe as the commodity itself, but there is a strong correlation between the miner stocks’ relative performance and the absolute returns from gold; the iShares MSCI Global Gold Miners ETF(RING) has surged 19% in the past three months, while the S&P 500 lost 2.6%.

“There has simply been more financial, economic, and geopolitical turbulence over the last two decades than there was in the period 1945-2000,” wroteCumberland’s Kotok, “It’s clear that a post-millennial flight from risk and into gold has been a powerful and globally consistent pattern.”

For the decades to come, holding some gold as ballast might not be a bad idea. 

Write to Evie Liu at [email protected]

 

 

 

Evie Liu is a business and financial journalist with a passion for data-driven reporting and visual storytelling. ... o Reported news on stock market, public companies, investing, economy, personal finance, etc.

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