Through the many financial crises suffered in the modern era, the yellow metal has been a haven and, many times, a great inversion outperforming the financial market returns. At the beginning of 2020, no one could guess such an event as the global pandemic. A few bearish investors, like Michael Burry, saw the indexes and especially the S&P500 trading well above its fair price and created a short position in the main indexes; the famous doctor nailed his short bet yet again.
The humanity and specially developed countries are facing its biggest challenge since War Word Two; the S&P500 was trading at 3.300 points in February 2020, but hit by the COVID-19 outbreak fell sharply to 2.200 points in March 2020, a loss of 1.100 points (or 33%) in less than one month. Now, at the end of May, the S&P500 has reached the 2.900 points. It looks like financial markets think the pandemic is over, but unfortunately it is not. What has changed? To put it in a nutshell: the FED and central bank behaviour.
During the great recession the FED started printing money, reaching a balance sheet which is as high as 15% of U.S. GDP. At this moment May 2020, this percentage reached 30%. This huge amount of money has been used to maintain liquidity in the bond system and to keep the current financial system going. This is the main reason why stock markets have raised sharply again. However, this massive monetary expansion across the globe could create very soon inflation and dilute the value of the currencies. Although in 2008 many believed this unconventional monetary expansion would lead to inflation, after a decade we haven’t seen such a scenario. Nevertheless, this time the amount of printed money is higher, the unemployment rate at its highest in a century and the epidemic risks are still unknown. The chances of more unlimited quantitative easing are high, and eventually this will lead to inflation. Even without extraordinary inflation, during the 2008 financial crisis gold prices rose by 20 percent while the global stock markets lost 20 percent during the same period. As tension and fears grow over the economy also the price of gold will rise.
Another factor to consider are the real interest rates (interest rates adjusted by inflation). Currently, the real interest rates are negative, and since it has an inverse relationship which the cost of holding gold it could be confirmed, the current costs of holding gold are relatively low. The yellow metal has seen its value rise in the last months almost reaching the 1800 dollars per troy ounce. However, I believe there is room for even higher gold prices. And there is one way of investing indirectly in gold with higher returns than physical gold: Gold miners.
During the outbreak of COVID-19, the gold price almost reached its historical maximums prices which allows gold miners to sell at higher prices, increasing its top line. Furthermore, the fear of the pandemic and the current financial markets conditions have provoked a skyrocketing demand for physical gold. On the other hand, the drop in the oil prices will reduce the AISC of the miners significantly, since it is one of its main cost. Both factors would have a great effect on the bottom line on the gold miners. Furthermore, gold miners are often located in isolated places, where social distancing can be respected more easily, so the lockdown of businesses would have a lower impact on the mining sector when compared to other sectors.
The Gold Miners ETF (GDX), which replicates the performance of the biggest gold miners worldwide has seen its price increased by 75% year to date. Although this is an impressive performance, I firmly believe that with the conditions expressed above miners are going to see its value increased even more. It is worth mentioning that the index is currently trading 80 percent below its peak it reached in 2010, but the amount of quantitative easing is twice as high. This creates the perfect opportunity for investors to hedge their portfolios or speculate against more monetary expansions.
Disclaimer: These comments on latest gold miners are of Alfonso Hernández de Castro personally. The comments are his personal opinion and thus does not necessarily reflect his employers opinion on the topic.