Gold has been reaching record highs over the past few years. Can you talk about the macro environment that’s been causing that?
What we’ve been seeing ever since it became apparent that Mr. Trump was going to be the President of the United States, is that the world may be in a much more restrictive trade environment, meaning more tariffs on China. It also means tariffs on its closest trading partners, Mexico and Canada. At the time of this interview tariffs of 25% have been imposed on virtually all goods out of Canada, with the energy sector tariffed at 10%. But, they may not last in their current form.
Most people in the market believe that what we’re going to see is some sort of inflationary shock down the road. Economists like to call it a negative supply shock. The question is, will the Federal Reserve accommodate? The general consensus is that the US Fed has a dual mandate, one is price stability. The other, an equally important mandate of the Federal Reserve under the Federal Reserve Act, is maximum employment. So, it stands to reason that if the economy does slow down, even if inflation isn’t at target, the assumption is that the Federal Reserve might ease, nonetheless. That ultimately means that inflation could stick around at above target levels for much longer than many expected six months ago.
This has caused a lot of interest in gold. Gold is considered a natural hedge to the extent that it uses real labour and capital to get an ounce of gold out of the ground. I’m talking about machinery and other productive capital. We know that over the last 40 years or so, there’s been a strong relationship between the cost of producing a marginal unit of gold and prices. We use the 90th percentile as a measure. Gold has adjusted to those higher prices. So, what we’ve seen is a combination of firms betting that gold will be a good hedge against inflation and potential lower real interest rates. The concern is that the US may pressure its central bank to be more accommodative when it should be focusing on lower inflation. There are certain statements from Washington that lead us to believe that there will be political pressure on the US Central Bank.
Monetary metals like gold and silver have not been exempt. That means once you impose these tariffs, the US price will be higher than the global price, and ahead of that, we’ve seen large inflows into the US market. People have been taking positions in gold, and COMEX saw a very large inflow of physical gold. So, a lot of financial institutions would play the exchange for physical (EFP) trade, the differential between the futures price of the COMEX versus the local London price. That drove flows move into the US.
The problem is that not all gold is good delivery against futures contracts in the US, certainly big bullion bars are not. Logistically, that gold lives in LBMA and Bank of England vaults, and there are constraints to get gold out of the Bank of England. It’s not an easy feat to move very large amounts. There are operational constraints that have slowed things down. The gold at the Bank of England has been at a negative premium or a discount because of that congestion. And when you take those big bullion bars out, you still have to refine it into bars that are good delivery for the comex futures contracts. There’s only so much industrial capacity to reformat those bullion bars to the other form.
That has created a perception that there might be a shortage of gold. Well, there’s really not a shortage of gold. There’s plenty of LBMA gold and Bank of England gold. It’s just we don’t have the right type of bars.
Longer-term macro views are the concern that the US Federal Reserve might not be as diligent on the inflation front. Last year, we saw a third-year record of central bank or official sector purchasing well over 1,000t. So, 2022-2024 were massive years, and this year certainly looks like we might see central banks buying.
There’s been a lot of empirical evidence showing that central banks around the world in aggregate are substituting their treasury and other fiat holdings with physical gold. We’ve seen that trend for a while. The People’s Bank of China has been very active over the last few years. They were on hiatus recently, but they started buying again a few months ago. So, we’re worried about debasement of the US dollar, inflation in the US, and central banks are hedging. But, there’s another important factor, especially for non-aligned countries like China, that are potentially looking to build gold positions in their foreign exchange portfolio to insulate themselves against any potential restrictions or sanctions levied on them by the US.
We have no way of knowing what happens with Taiwan as far as China is concerned, but I think the relationship between China and the US is not getting friendlier given the current political landscape. So, this is just risk mitigation for the People’s Bank. We certainly have seen an example of that when Russia invaded Ukraine and their assets in euros and dollars were sanctioned. There’s a lot of belief in the market that Russia was able to utilize its gold reserves for credits with some trading partners. So, big macro picture, we have gold as a hedge and geopolitical reasons for central banks to hold gold, particularly for non-US aligned countries.
As we look into the future, ore grade rates for gold, as well as copper, etc. are getting lower and lower. Theoretically, you can say that gold will reflect the cost of production, which is driven by labour and productive capital costs, which adjust to inflation. Given that ore grades are getting lower, we could have a situation where you use more of those more expensive resources to extract any incremental unit of gold down the road. Why is that important? Well, it means that we could see a situation, particularly if there’s some sort of monetization happening, where real rates aren’t rising because the Fed steps in to fund a bond market, where gold might outperform the yields generated by the bond market, making it a very good inflation hedge down the road.
What about gold purchasing on a more retail or individual level?
We’ve seen evidence that ETF purchases have gone up, though it hasn’t been huge. We’re nowhere near the record of gold holdings by ETFs, but it is moving higher. That’s going to be tough, because as gold went up a lot, I think the retail clients may be revaluating their appetite for it. Typically, what we see is, whenever there was a big rally in gold in countries like India for example, you would take a pause, see where this is going. And if prices keep up, you consolidate and start your appetite again. So, ultimately, retail investors will participate in the gold market as well as central banks and the large institutions.
It also means that recycling is going to get a bump, mainly because you can trade in your gold and get significantly more money than two years ago. And that is very tempting. Ultimately, I think gold is going to fire in all cylinders down the road, through central banks, institutions, and private individuals as well.
Silver’s performance outlook seems to be quite good. What’s your take?
We like silver a lot. My colleagues have been writing that silver is due for a squeeze. The available silver that is mobile is becoming less and less because as the net-zero economy moves higher, despite the fact that the US is not all that interested at this point, we think that this market will continue to be strong. There is going to be more silver content in vehicles because of all the electronics. There’s a lot of appetite globally for hybrids, and they are much more electronically driven than the previous generations of cars. That extends to internal combustion engine (ICE) vehicles as well. They have a lot more electronics than they used to.
The technology is improving quite a lot. The grids are going to have to grow. Whether we have a bit of a slowdown or not, I think the economics in the long term will tilt towards wind power, solar, and nuclear, and silver is an important component. And with industrial demand at record levels and still growing, the silver market is well over a billion ounces now. We’ve seen several years of significant deficits, and that’s eroding the silver available in the market. At some point, we might run out, then we have a situation where you have a fashioning of silver, where the folks with the highest marginal unit of revenue will outbid others. So, there could be some demand destruction. It will also probably mean that we’re going to see more interest in building silver facilities, but that’s not going to happen for a long time.
Immediately, it could mean that you’re going to get a bump in recycling as well because of the high prices. But silver hasn’t been as high as we thought. We think it should be about US$36 by year-end. We’re not there yet, but we’re quite confident that as demand continues to be firm and the rate of increase on the mining side and the recycling side is not enough to prevent global deficits from forming and eroding those free-floating inventories that can fill up the gaps, this means that silver is looking pretty good.
It’s an extremely valuable metal for the industrial sector, used in chemicals, catalysts, jewellery, and electronics. And there’s an investment component as well. It’s one metal that we think will probably outperform most others. Over the longer run, silver will probably become more like copper, more like an industrial metal in the way it trades, maybe not so dependent on gold like it historically has been.
Looking outside of gold and silver, what other commodities are top of mind for you right now?
Oil is something that we’re going to continue to use for decades to come, though it’s tough to forecast. But there’s every indication that we’re not getting rid of oil anytime soon. And with the new US tariffs, we think that might start raising prices, certainly in the US, mainly because demand is price inelastic. You can see price go up 10, 20% and you still use the same amount of oil. In the short run, it very tough to get your car to be more efficient, or not drive to work, or change the logistial infrastructure of moving capital goods, groceries, and people around, so we are stuck with these systems. It also takes a long time to respond to price signals. So we do think there’s a chance that prices will go higher, but there’s also a geopolitical component which could send energy prices quite high. Then that will play into the cost of production of everything from copper to gold and silver as well.
The new administration in the White House is getting quite aggressive with Iran. Based on the previous presidency of Donald Trump, we saw Iran lose 1.5-1.9M barrels per day of production. This could happen again, but that very much depends on how stringent those sanctions are. The issue continues to be Iranian aggression in the region, certainly from the US and Israeli perspective. And the other big factor is its nuclear weapons capacity, which is making the Trump administration quite nervous. It’s making everybody nervous. So, that could lead to higher prices as well. But we don’t think it’s the end of the world there mainly because OPEC has probably well over 5M barrels per day of spare capacity, so they can compensate. With Iran, the concern is that there’s a wider conflict in the region, which involves the Straits of Hormuz, which sees maybe 17M barrels per day plus of oil flowing through it. That could be quite devastating, and prices could go up markedly higher. And of course, there’s the Russia-Ukraine conflict, though the impact of that is marginal. Russia is already trading most of its oil despite of the sanctions. We ultimately think that there is an oversupply of oil right now. There is weak demand, particularly from China, which has typically been the driver of oil demand, but now it’s slowing down. Tariffs aren’t going to help. So, we ultimately think that prices aren’t going too far anytime soon, despite of potential geopolitical factors.
Can you highlight a few key factors that we should be looking out for when it comes to gold and silver over the next couple of years?
We have to be very mindful of what the White House does and what US policy settles at, what tariffs look like, what geopolitical relationships are between the US and Russia, between the US and China and Europe. I think tariffs are going to be on top of mind right now.
Another critical factor is how the US Central Bank responds to higher inflation due to tariffs. In the US, we’re also seeing a much more restrictive immigration environment, particularly pertaining to migrants, which have traditionally supplied quite a bit of cheap labour for the agricultural and other labour-intensive sectors. That could all be inflationary and it’s going to be key if the central bank focuses on its price stability part of the mandate or maximum employment.
If they focus on the maximum employment in response to weaker economic numbers, then I think gold and silver could benefit a great deal from that. Oil would be probably agnostic to monetary policy for the most part, because its demand is price inelastic. But if the economy is slowing down because maybe interest rates stay higher, oil demand could disappoint down the road, and that could serve as a negative.
So, there are a lot of moving parts, and I think more so than in previous cycles, we’re going to be very much focused on foreign policy, fiscal policy in the US, domestic political machinations and policies related to America’s relationship with its trading partners, with NATO partners, with Russia, and with China. We are going to be very, very closely watching how the fiscal side looks, in particular. If we see the Trump tax cuts continue, or maybe even additional tax cuts, the US may very well see even higher deficit to GDP ratios than it already has. We’re running at around 6% now. That could be a reality for the foreseeable future. And we’re going to have concerns of how this is funded down the road. We suspect that we might see higher interest rates, if things are left alone, to pay for this. But if we see a government that is more interventionist in monetary policy, that could change. But I think uncertainty is probably a friend of precious metals and gold in particular.
