Recently, the U.S. Federal Reserve Chair, Jerome Powell, made a speech in Jackson Hole that sent the stock market crashing. He noted that fighting inflation is the Fed’s priority, therefore, ensuring continued high interest rates and slower growth in the economy. What has been the market sentiment coming out of this speech? And what’s the impact that you’re seeing on the gold markets?
The more aggressive and hawkish the Fed is, the more negative that is for gold. Higher interest rates means the opportunity cost of holding gold is higher. When you have higher rates, the gold prices go down, which is what we’ve seen. Regarding Jackson Hole, there was an expectation that we’d get a more dovish tone from the Fed, but we didn’t get that.
Today, we received the most recent U.S. inflation data, suggesting that inflation in the U.S. is 8.3%. And for context, the expectation is 8.1%. So it’s higher than consensus expectations. And it’s only a little bit lower than what we saw in July, which was 8.5%. And of course in June we had the peak of 9.1%. So you’re really seeing this persistent high inflation. Which is a challenging environment for gold.
So, your bull and bear case, what do you see happening moving forward for the market?
The bear case is when the Fed continues to raise rates aggressively and tackling inflation is pretty much their only objective. So, you’re going to see higher interest rates. And if their plan works, you’ll also see lower inflation. Higher interest rates and lower inflation means that real rates will trend higher. And when that happens, typically you see lower gold prices. The bull case for gold is at some point, the Fed pivots and they say, look, if we continue to raise rates, we’re going to cause widespread economic issues.
We’re going to have very high unemployment. Of course, the debt structure of the United States and even globally is very different now than it was the last time rates were high. So they may come to the realization that we actually can’t raise rates past a certain point. If interest rates pause, that would be positive for gold. And a lot of economists think that results in a stagflation-type environment, rates have been raised so much that its slowing down the economy, but inflation remains stubbornly high.
And so you have stagflation and that could be positive for gold. The other bull case for gold is total recession. because it’s considered a safe haven asset and it’s an alternative to holding equities or bonds. Gold prices today are also elevated. If you think about how strong the U.S. dollar is, how high interest rates are, gold prices are still above $1,700/oz, which historically is an elevated price. Why is it still elevated despite these macro headwinds? And the answer is because people are afraid of stagflation; they’re afraid of a recession.
On the E side of ESG, there’s room for improvement
Do you think gold will remain a haven moving forward?
There’s an argument that if you want an inflation hedge in your portfolio, you have multiple choices. You have gold and a variety of cryptocurrencies. These alternatives are part of the reason why gold isn’t doing better. Fast forward to this year, when inflation is high, gold has actually performed function as an inflation hedge. It’s been one of the best performing asset classes.
On the investment front, we were seeing a little bit of a disconnect between gold performance and gold equities performance. Can you explain a bit about what you see happening here?
I know gold has been up and down this year, it went over $2,000/oz. Now it’s around $1,700/oz. And given the fact that gold is elevated, it’s surprising that gold equities haven’t performed better year-to-date. In an environment where gold is down 4-5% this year, gold equities are down like 30% or 25%. It’s been a complete disconnect. Which is part of the reason we see so much value now in gold equity specifically, because we think that they have been oversold.
So why such a significant decrease in equities? Why is it that investors are selling off gold equities? If the commodity is doing better than most asset classes. And the answer is a lot of investors are concerned about cost inflation. Investors are concerned about higher costs and lower margins, which has resulted in the entire gold equity sector re-rating lower because of the fear of margins getting eroded.
We have seen some margin compression, but not nearly what is being reflected in stock prices today. These companies are still very healthy. Most of the gold producers now are paying north of 2% dividend yields.
So, you have these fundamentally strong companies, the gold commodity is okay. And yet the valuation of these gold equities is low. In fact, many of the companies I cover are trading at valuation multiples now that are 10-year lows. So, if you want exposure to gold, these equities look inexpensive at this stage.
Many analysts and investors talk about gold’s place within an investment portfolio. Are there any overall ideas about how it’s best placed within your portfolio?
5% of the portfolio should be allocated to gold, and there’s different ways to do that. Gold tends to be uncorrelated with stock. So, if you have an environment where you have a downturn in the stock market and equities more broadly, you want something that can at least be uncorrelated to that to offset and have a better overall performance in portfolio. So that’s where the 5% comes from. To attain the 5%, you can buy physical gold, buy a physical gold ETF, or you can buy gold equities.
And so we see an opportunity for generalist investors to start allocating more to gold. And in fact, when that generalist capital comes into this space, it has a huge impact on valuation multiples.
ESG has been really front and centre of all the industry discussions that we’ve had over the past few years. How do you see this latest discourse on ESG impacting miners and how are they finding their way forward?
I feel like every year there’s like a theme for the miners. Last year the theme was ESG. This year, the theme seems to be more about cost inflation, but that focus on ESG is still very much there. In fact, most corporate presentations, the first or second slide is about ESG or sustainability, that wasn’t the case years ago. I think what’s happened now is investors have become more sophisticated. The companies themselves are responding to those sophisticated investors about ESG. And so there’s more nuanced and specific discussions about how to decarbonize.
Now the discussion has become much more sophisticated where it’s, well, what is the pathway to get there? Where are most of the emissions coming from? Those are the types of things these companies are talking about, but the discussion has become more nuanced and more specific.
The gold mining sector is also really starting to communicate the economic and social benefits of these mines. Frequently, the best paying jobs are at these mines. And there is tremendous economic benefit from the jobs, buying supplies, locally, the tax revenue for the host country etc. This is particularly important for countries trying to balance their budget especially during the pandemic, etc. So I think that’s something the mining sector can highlight for sure. But definitely on the E side of ESG, there’s room for improvement, and you’re starting to see a lot more specific commitments on renewable power and decarbonization.
