A little horn tooting to start.
I wrote an article in late June of 2019 entitled My Brief History with Gold and What to Buy Now about the technical breakout in the precious metal to a six-year high, in which I hilighted five stocks, based on analyst research, that could benefit.
The piece also detailed how my father, who worked in the stock brokerage business, did well in retirement investing in gold stocks post-2008 financial crash, and that I was a keen observer and sometime investor in gold between 2008 and 2013, or so.
But as gold languished for about eight years after its peak in 2011, I eventually lost interest to the point that I was very sceptical about any assertion that bullion was ready to break out because I had heard that so many times before from the one note gold bugs.
You know the ones who never change their tune espousing the view that easy money central bank policies will inevitably lead to hyperinflation and stratospheric gold prices.
So last year’s breakout marked my reawakened interest in gold and gold stocks. Smart money investors were also on board with Paul Tudor Jones, for example, the billionaire behind Tudor Investment, having said that a very accommodative Federal Reserve combined with geopolitical tensions make gold a “screamer”.
Jones said at the time:
“I think one of the best trades is gonna be gold. If I had to pick my favourite bet for the next 12 to 24 months, it’d probably be gold…if gold goes to 1400, it goes to 1700 rather quickly.”
Right-O, Mr Tudor Jones.
Fed Adds Fuel to Gold Fire
Now, the Fed’s massive, pandemic-induced, open-barrelled multiple bazooka assault of cash to prop up financial markets has put gold in what looks like a perfect storm for further gains with interest rates at rock bottom, the U.S. dollar sliding and little competition from bond yields.
The five stocks featured in that article a year ago have fared very well with gold royalty company Franco-Nevada (TSX:FNV;NYSE:FNV) performing the best with a gain of 97 per cent, as of this writing. (Those gains naturally exacerbated by the pandemic.)
But a lot of the easy money in gold has been made. Now what?
Ed Yardeni of Yardeni Research said in a recent note the melt-up in precious metals makes sense for the following reasons:
- A pandemic.
- Violent civil unrest.
- Extreme political partisanship.
- A rapidly escalating Cold War between the U.S. and China.
- A game of chicken between the U.S. and Iran in the Strait of Hormuz.
- Out-of-control fiscal and monetary policies.
- A possible left-wing regime change on November 3.
Gold vs. TIPS
Yardeni also looked at the relationship between gold and Treasury Inflation Protected Securities (TIPS), which investors use to protect against a rise in inflation.
Gold and TIPS are highly inversely correlated, meaning when gold is going up, TIPS’ yield is usually going down and visa versa. TIPS’ current yield is negative as investors expect inflation to pick up, making gold an attractive alternative.
Yardeni pointed to comments in a recent Wall Street Journal article which said:
“Falling real yields can boost the economy by weakening the U.S. dollar and spur investors to buy riskier assets because inflation is causing them to lose money on their bonds.”
Gold vs. U.S. Dollar
Another key relationship for gold and its prospects is how it moves compared to the U.S. dollar. Yardeni provided a helpful chart (below) that showed how between 1994 and 2015, “the price of gold was broadly inversely correlated with the trade-weighted dollar.”
Gold and the dollar then moved mostly in lockstep through last year, but have now disconnected again since the market bottom in March with gold benefiting from a weaker greenback, which is down more than six per cent since late June.
Goldman Sachs, meanwhile, is bullish on gold having raised its price forecast to $2,300 an ounce.
So how much should an investor allocate to gold and/or gold stocks, if any?
David Morgan, publisher of The Morgan Report, a closely followed precious metals newsletter, told me earlier this year that because every fiat currency eventually fails that investors:
“…Need to hedge. You don’t need to put your life savings in gold. You don’t need to have your weight in gold. All you need is to have a portion of your assets in the gold market.”
Morgan’s preference is to buy physical gold and beyond that he said investors’ big money should go into the top tier, unhedged gold companies, particularly the streamers, which earn royalties from gold mining companies in exchange for upfront payments to finance the mines. Franco-Nevada is the biggest and the best at doing that.
Odds Worse Than Vegas
If investors want to dabble in the more speculative junior gold exploration companies, Morgan recommends “betting a little to win a lot.” But he adds, “the odds are worse than Vegas.” That’s because, according to Morgan’s experience, only one half of one per cent of exploration companies actually develop a producing mine.
On the bearish or indifferent side of the gold equation is John O’Connell, Chairman & CEO of Davis Rea Investment Counsel. He’s not a believer in gold and doesn’t hold any gold stocks for his clients.
Hear his take from the Davis Rea Quarterly Conference Call on why he thinks that, based on historical returns, gold has not proven to be a good hedge against inflation nor against extreme market volatility.
And O’Connell’s experience tells him that capital-intensive gold companies have also not been a good bet over time. (A brief Q&A on gold starts at 46:15).
Here’s my interview with David Morgan from January of this year.
Also, watch my interview with Franco-Nevada CEO David Harquail in late June of 2018 for perspective on the company’s highly successful business model. Interview starts at 2:35.
Related stories: Gold Has “No Role” in Portfolio of Wealthy Clients