I am always slightly cagey about sponsored research. It can provide a useful service in simply stating the obvious, but one should treat any forward looking predictions with great caution. That said I’ve always found the frequent reports by Charles Gibson of Edison on mining stocks and especially gold useful and thought provoking – though one obviously wouldn’t expect him to be bearish given how many resource stock clients Edison boast! Nevertheless, his latest gold report – A Golden Future: The outlook for gold and gold equities – is worth a quick read through. You can download HERE. It’s a short and well argued, bullish paper which touches on a number of key themes, notably gold and central banks, QE and deflation plus the likely impact on gold equities.
Central banks, QE and Gold
We’ve often heard about the relationship between gold prices and the monetary base but its nice to see this mapped in some detail. Apparently since 1967, the price of gold has shown an extremely strong (0.909) correlation with the total US monetary base. Using this heuristic Gibson projects through to the gold price….
“Applying the strict mathematical historical relationship between the two, a total US monetary base of US$3,260bn at the end of July 2019 (ie at the end of the asset reduction programme) implied a gold price of US$1,291/oz.
Given the extent to which the gold price has diverged from its strict empirical relationship in the past, it could have been expected to reach as high as US$1,543/oz (in a bullish gold environment) with an additional US$700bn from the coronavirus stimulus response taking the total US monetary base to a record US$4.2tn, the implied gold price has rocketed – initially to US$1,619/oz, with an upper level way in excess of US$2,000/oz.
But with unlimited bond buying, the sky is the limit. For every US$100bn by which the total US monetary base exceeds US$4.2tn, the gold price may be expected to be US$33/oz higher than US$1,619/oz. Anecdotally, there is some evidence to suggest the Fed has already spent close to US$2tn buying bonds to date, which, all other things being equal, should take the total US monetary base to a record US$5.5tn and the gold price to over US$2,000/oz and potentially as high as US$3,281/oz. At its current level of US$5.1tn (source: Federal Reserve, 13 May 2020), the gold price should be expected to be US$1,892/oz, with the potential to rise to as much as US$3,067/oz”
Gibson has also looked at the return of (c.2500) gold equities since the start of the year in US dollar terms:
- “Over the first 4.5 months of the year, the average performance of a gold equity was 46.4%.
- This compares with the performance of gold over the same period of 14.5%; in general, therefore, gold equities are showing a geared relationship to the price of gold, which is as expected.
- Nevertheless, of the 434 counters analysed, the share price prices of only 233 have risen, while the share prices of 201 have fallen. Within the context of this analysis, there is also a general out performance of precious metals’ companies listed in London. Thirteen out of 25 companies (52%) listed in London outperformed the gold price in the period in question, compared with 168 out of 434 (39%) for the sample as a whole. At the same time, 17 out of 25 London companies (68%) generated a positive total return for shareholders during the period, compared with 233 out of 434 (54%) for the sample as a whole”
- “At a stable price of US$1,700/oz, we would expect the share prices of existing producers to stabilise (or decline in the event that this scenario is also attended by a concurrent increase in the oil price) and the share prices of juniors to continue to outperform over the longer term (eg 2.5–5.5 years)2.
Last but by no means Gibson repeats an obvious fact – that gold is not always a perfect hedge against rampant deflation. But in relative terms it should outperform other assets:
“In this case, gold may not be able to resist deﬂationary forces bearing on all other parts of the economy and its price too may fall. Despite any declines, in line with historical precedent, we would expect the gold price to nevertheless outperform most other asset classes in this scenario as it did in the 1930s (the gold price actually rose from US$20.67/oz to US$35/oz during the 1930s).”