In late 2022, the US Fed announced that they were going to be focusing on fighting inflation, and so keeping interest rates high for the time being. What are some of the expectations now as we are well into 2023? How are the gold markets being impacted, and where do you see market sentiment heading from this point?
Marcus: Before we look into the future, maybe let’s have a look into the past. Last year we were in the most difficult and challenging environment for equities and bonds. Gold did well, and it kept its value in most currencies. In US dollars, it was flat, but it was up in most other currencies, Sterling, the Yen, the Euro, so I think it points very much to the key role that gold has in a diversified portfolio, which is like a storage of wealth.
Going forward, I think gold will maintain that role. I think the Fed policy took lots of investors by surprise. Investors still follow an old narrative, a narrative that was very important for the past 20 to 30 years, which was low interest rates, low yields, low inflation, and I think there is a bit of an expectation that going forward things will remain the same, but they won’t. That is our view.
Ian: With regard to the Fed, you can lose an awful lot of money listening to what people tell you, because they’ve got a serious habit of getting it wrong. Not that long ago, it was that there was no inflation. But over the last 18 months when you were seeing oil prices go up from US$60 a barrel to US$120 a barrel, it was fairly obvious that you were going to get inflation, and anybody that sat holding 30-year treasury bonds, for example, lost an absolute fortune last year, and now belatedly, they’ve decided that there is inflation, and they’re going to do everything they can to fight it.
They run the serious risks now of getting the recession wrong, they’ve got inflation wrong, now they’re potentially over-tightening. You look at the yield curve in the States, and it’s signaling recession. You’ve got to be a little bit careful with that, because the old joke in the bond market is that the inverted yield curve has forecast 10 out of the last three recessions. The Fed spends all day looking at jobs numbers which are lagging indicators. It’s like driving a car looking through the rearview mirror. They keep putting these rates up, and they’re not giving enough time for them to take effect.
If you split gold, silver, and the gold and silver mining shares, you’ve got different camps buying this asset. With gold, the main buyers have been the Asian central banks. We think it’s probably China, but there are other central banks in there as well, and they’re pretty much immune for what the Fed does anyway. They’re buying it for different reasons, more to do with up-and-coming currency realignment and de-dollarizing their accounts to avoid US sanctions.
Central banks tend not to buy silver, so silver hasn’t done as well as gold. Finally you’ve got mining shares which are dominated primarily by US investors, and the US investors not only lost a fortune last year in the bond market, they also lost a fortune in all these US tech shares as well. So you have a wipe out of capital, mainly from the US, estimates of around US$32T, US$35T.
So, we have different camps driving different assets within this space, and you must think that the central bank buying is going to continue, so out of all the assets that the safest play is probably to buy gold bullion still, that would be our view.
Wayne: From my side, we target a gold price at above US$2000 by the end of this year, and the reason we have that target is, because as we moved towards the end of last year, the labour market was cooling, inflation was shifting lower, and domestic consumption in the US, was starting to show cracks. What we’ve seen from the data in the very, very short term has been the complete reverse, and markets have repriced expectations for the Fed. The key risk to gold in the short term is that the Fed does more than consensus is currently, and I think when you look at pricing, the Fed is expected to have a terminal rate of about 5.2%.
What is very important is the role of gold in a diversified investment strategy
The one thing that I think is almost guaranteed is that over the next 12 to 18 months, the Fed will not be holding rates at the 5-5.5%. They’ll be trimming rates and that will see a commiserate rally, particularly in precious metals, and as Ian has pointed out, silver and silver platinum will be relatively cheap compared to gold at this point.
From a hedging perspective, we prefer gold, because of its lower volatility on average compared to the options of silver and so on, and even gold miners. Of course, gold miners have the additional risk of operational issues. I don’t think we’ve entered in an up market trend for gold just yet, because we probably won’t see a trend form to the upside for gold until the Fed pause, and then people will begin to seriously discuss rate cuts.
In that context, I think both gold miners and silver have shown themselves to the out-performers in those situations, and so tactically you would be holding gold today as a hedge, particularly against US dollar debasement, and then after that you would be in a trend up market for gold. You would be certainly focusing more on silver and gold miners.
Marcus: For the average investor that might buy the yellow metal, they have a long-term horizon. If they buy it today or tomorrow, they probably look at wealth protection for the next 10, 20, 25 years. So, the price is not that important. I think what is very important is the role of gold in a diversified investment strategy.
And I’m always fascinated at the very low correlation gold has as an asset against equities. If you separate gold, be very agnostic about it and just treat it as a tool of wealth preservation. It should form a part of a very well diversified portfolio and an investment strategy.
Let’s look at gold’s role within an investment portfolio, are there specific strategies that investors should focus on?
Ian: I think it’s quite important to determine why these aging central banks are buying gold. That’s why I think the US Federal Reserve is not the sole arbiter of what happens in the gold market. Russia, which used to have about US$600B of US treasury bonds prior to the war in Ukraine, dumped a whole lot of treasury bonds and switched it into gold bullion. China is doing the same thing.
They will most likely soon get rid of every single cent of those US treasury bonds. They will almost certainly switch it into gold, which is probably what they’re doing now. China is a huge buyer of gold underneath the market, and it doesn’t matter whether the Fed puts rates up to 15%. It’s not going to stop the Chinese from switching their treasury bonds into gold.
China is buying gold for a completely different reason and other Asian central banks are buying it as well. There’s going to be a big currency reset. There are also countries like Saudi Arabia, UAE, and Argentina queuing up to join the BRICS. They’re obviously going to work on some alternative currency system.
Wayne: From our perspective, when we think about it in a portfolio, it’s obviously not just the hedging capabilities that gold has shown recently, where it’s been increasingly correlated to dollar moves and less correlated to real interest rates in the US. I don’t think that the negative correlation that it has with real interest rates is gone completely, just because gold is a non-yield bearing asset. And so the opportunity cost of gold does have a role, but nonetheless, I think Ian is right, that central bank purchasing is for a number of reasons, and those reasons are still present today.
We have shifted away from what was a very rapid globalization trend, and that is having implications with the central banks, and our big buyers in the market. I think it’s difficult to predict. We saw the material difference between the World Gold Council numbers on central bank buying, which is done by Metals Focus, and those numbers compiled by the IMF. That’s one element of forecast in the gold price now, where traditionally central banks were a secondary driver, now they’re fast becoming a primary driver, and it’s very difficult to predict their actions, albeit we know that the reasons they’re doing it, seem to be still in place.
One of the things that we noticed, particularly in most downturns in equities, is that gold does fall at the same time, but it doesn’t fall as much as equities, and that’s in part because people are using gold to raise cash due to its liquidity element. We found that (particularly at UBS) during COVID-19, it was very difficult, because refiners were shut down, and physical availability was very difficult. The fact that clients could still be able to realize what was the spot price in the market, through our own holdings, was very vital to them to be able to provide liquidity during what was very tight time.
Marcus: The characteristics and attributes of liquidity are often underrated, and during most financial crises, like we saw in 2008 and 2020, gold often doesn’t go up. A source of liquidity can be sold 24/7, and the timing of March 2020 is a very good one, because the bond markets were so illiquid then, so were they in October 2008. We had the liquidity in the global financial system which was very problematic, and it again has been reflected in the bond market, and I think that gold was often the only source for institutional investors to raise immediate liquidity in a very difficult market environment.
Gold is a safer bet. You can always reengage, and buy it afterwards, and that’s also why gold often tends to recover very, very well in the aftermath of a global event, like we’ve seen over the past decade or two.
Let’s look at how investors assess the space, and how you assess opportunities, whether it’s within mining projects or within the ETFs, the equity space.
Wayne: In mining, there has been a reluctance to increase investment significantly, given the volatility we’ve seen in prices over the last few years. Now, we are starting to see a situation (in the last couple of weeks) where there was a material shift to a potential M&A transaction, and that shows a couple of things.
Firstly, some of the very large operators are seeing a positive outlook for gold over the next three to five years. The second point I’d make is that, as reserves dwindle, either you must do greenfield developments, some brownfield expansion, or you must do M&A transactions to increase your overall volume of gold that you’re holding.
We’re starting to get some pressure points for several companies, who need to expand their tappable reserves. It’s also been interesting seeing some of the diversification strategies that gold companies have taken, i.e. either looking at commingled metals or actually focusing more on some other materials, such as copper for example. I think that will continue.
Known provable reserves are diminishing pretty quickly, and companies are starting to look at that positive outlook for the next five years, and organize themselves to make sure that they have access to mine supply – which is still relatively easy to get. I think that’s also a key given the fact that the mining costs of production have continued to rise, and that access to gold reserves (in a relatively geopolitically stable environment) has become more difficult. So those companies with access, particularly the small to medium size companies that have those reserves in relatively geopolitically stable countries, seem to be in much higher demand, particularly given recent M&A events.
Ian: At the end of the day, if investors don’t come in and buy gold shares, other mining companies will, and that potentially will bring a bit of confidence back to the sector.
You need a bit of confidence to rebuild, and nothing will do more to rebuild that confidence than big mining companies starting to do takeovers, like Newmont trying to do its Australian takeover, because they know the sector better than anyone. If they perceive there’s value there, then investors will say, “Well okay, maybe these assets are quite cheap”, which they are, historically they’re not expensive, but they need something, they need a catalyst to get the ball on them.
Marcus: A helicopter perspective is always important, and assets move in cycles. We had a very fascinating period between 2001 and 2011 where gold stocks outperformed the S&P considerably. Then we had a period of, call it American exceptionalism, where the S&P and NASDAQ were blowing everything out of the water post-2009, up to about 2020, 2021. Hence, one needs to be very mindful that these shifts take place, these trends last a long time, and the relative returns can be exceptional.
Where do you see market sentiment heading? You said, “It’s very tough to predict”, but maybe after closing out this discussion, what do you think for the market moving forward?
Ian: We do a lot of our own in-house cycle analysis, and we think we’re at the cusp of a commodity super-cycle that’s going to last three or four years into 2026, 2027, which will also take up quite a big bull market in global equities. So we are very bullish on a three four-year view on global equities, very bullish on particularly commodity-based equities, not just gold and silver miners, but the big metal miners like BHP and Rio Bond market.
Do you see any risks or potential barriers associated with your outlook?
Ian: The Fed is potentially overdoing this rate tightening cycle. Someone described monetary policy like a brick on an elastic string, where you pull and pull and pull, and nothing happens and then the brick hits you in the face, and I think that’s what’s happening here with the Fed. They keep raising rates every five minutes, they’re not allowing enough time for the rate rises to take effect.
A US recession doesn’t mean a global recession. India’s grown five or 6% a year, China’s going to be growing five or 6% this year. The whole of Asia is potentially going to boom over the next three or four years, so I think again, you’ve got to strip out the EU, the UK, and America, and compare that to what’s going on in Asia, and I think Asia is potentially where all the action is, all the growth’s going to be. It’s the Asian central banks that are buying all this gold up, so I think there’s going to be a divergence between what happens in the West, and what happens in the East.
Wayne: My view particularly with gold is that Asia is the place to be for the next few years. I think generally materials and mining are going to do very well, but I’m more concerned about the short-term risks.
The Fed continues to tighten at a rapid clip, and while they will inevitably bring inflation down through a more material downturn in the US, this will be negative for the dollar, and positive for gold, in the very, very short term, that can still do a lot of damage to the gold price.
On a longer term perspective, real interest rates are more likely to be down than up from here, and subsequently the dollar is more likely to be weaker than where it is today on a 12 to 18 month basis, and that signals to me that you should be using gold as a hedge, and if you don’t have gold in a portfolio context, then you should really seriously look at your portfolio.
Marcus: Every forecast obviously has a risk. If you have a portfolio you should have a well-diversified strategy. I think there will be a lot of noise-changing narratives over the next couple of months, when you take a look-through approach, (which is based on government debt), it is only going to get worse. It was fueled by COVID-19, it will be now fueled by many other factors. Government debt is destined to increase and that doesn’t bode well for the strength of currencies, because that bubble is not going to burst.
