Whither gold?

Before I dig into the gold narrative, I thought I’d quickly mention the polling results of Morgan Stanley Europe’s Global Insights Day 2021 . “Polling at our annual January conference suggests investor sentiment is very bullish, for example, investors’ current level of risk exposure is 2nd highest in 10Y and there is a record preference for Cyclicals. Most expect Value to lead in 2021 with Europe & EM likely to outperform.” I have to say that fits very nicely with my own view which is also overweight EM and Europe (especially UK equities) and more neutral on tech and slightly bearish on China short term.

Anyway, perhaps I am wrong and all those respondents to the Morgan Stanley event are hopelessly optimistic. That is absolutely possible which is why I constantly wonder on this blog what the best hedges might be. Today I want to suggest mid cap gold mining equities.

I can hear lots of readers quietly despair but bear with me. Last week I was chatting with an old friend who can usually be relied upon to have a (positive) view of gold. He knows my view which is that the precious metal is mostly a barbarous relic. But we both agreed that the excited talk that bitcoin was going to replace gold was b******s. I completely accept that bitcoin for instance has real value to many in the developing world and that in addition many institutions are diligently diversifying their alternatives hedges, partly in response to client requests. So one can believe that bitcoin has diversification value, especially in parts of the developing world, without believing it will replace the oldest store of value. If I were a boring Swiss banker with constantly anxious clients – worried about the collapse of money fiat – I can get a 5 to 10% hedge allocation but the idea they’ll sell their gold bars to buy digits strikes me as lunacy.

So, in my view gold and especially physical gold will remain a core hedge against monetary mayhem. And I think the gold price supports this analysis. I’ve been struck by how relatively stable gold prices have remained – sure, they have come off a bit but there seems to be steady support around $1800. And if that is the case the gold miners should be rolling in cashflow. Which many are.

Wisdom Tree – who have a large exposure to physical gold trackers – today put out a gold outlook note (At the crossroads of hope and fear) which observed that a consensus scenario wahich painted a scenario where “gold could rise to US$2130/oz, thus breaking a fresh high, surpassing the US$2075/oz level reached in August 2020.” The table below sums up the thinking behind this view. Personally I think this is a bit optimistic if I’m honest and I could see gold maybe testing the $1800  level as central bankers move up a gear in 2021.


Q1 2021 Q2 2021 Q3 2021 Q4 2021
Inflation forecast 1.5% 2.6% 2.0% 2.0%
Nominal 10-year yields forecast 0.95% 1.06% 1.14% 1.23%
US$ exchange rate forecast (DXY) 91.3 90.5 89.8 89.5
Speculative positioning forecast 250k 250k 250k 250k
Gold price forecast US$1830/oz US$2060/oz US$2100/oz US$2130/oz
Source: WisdomTree, data available as of close 30 December 2020. You cannot invest directly in an index. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

But in a sense, anything much above say $1650 is still fantastic news for most gold miners, which is why I have Newmont in one of my portfolios – the mammoth US listed gold miner is one of the lowest cost producers at scale. I’ve also seen that more than a few analysts have been upgrading Centamin on a similar logic – for full disclosure I also have Polymetal (not much) in the same portfolio. So, to repeat, you don’t have to be a gold bug to accept that many gold miners are doing well and will continue to do well IF gold remains the dominant inflation/central bank mayhem hedge.

This brings me back to my coffee infused chat with said old friend who’d gone aggressively long Junior gold miners, and specifically GDXJ, the VanEck Junior gold miner ETF – as an aside the media market cap of stocks in that portfolio is a very mid-cap $4bn.

My friend’s argument was elegantly simple. If you accept that gold has stabilized in an elevated trading range above $1650 (tick), then you might also accept that gold retains its long term hedging value (tick). That suggests that physical demand will persist even if all those pesky Indian families start to swap over from gold jewellery to local mutual funds (tick , on a bearish viewpoint). But there’s a longer term supply problem. Put simply capex has fallen and the potential for increase supply is just not there.

Cue a useful paper by Crescat Capital, a US based outfit that obviously has the hots for the precious metals space. I’ve nabbed four charts from a macro paper from the end of December which nicely sums up the key arguments on supply.

The first chart tells us there is a gold supply cliff – though I am sure this downward chart might reverse if enough money was thrown at it.

The next chart shows us that gold discoveries have also fallen away substantially. Again, I’m sure this might start to reverse if enough money was thrown at the problem.

This brings us to the next chart which shows that exploration budgets are still subdued.

Finally, to sum up, gold capex budgets have fallen back aggressively.

This brings me to my friends’ central contention.

IF you accept the argument above, then persistent high demand for physical gold should feed through into persistent high demand for mid-cap gold miners who have started to monetize their exploration assets. This could in turn spark an M&A phase where these mid-cap, cashflow generating outfits get snapped up by the low-cost majors looking for extra supply. This is a good old fashioned capacity crunch argument that sits independently of any view one might have about monetary mayhem or the end of the world. It simply says buy the mid-cap gold miners in GDXJ before the mega caps do.

The obvious narrative weak point is that persistent demand for physical demand withers away in a digital age and that in addition central bankers keep up their policy innovation and avoid a confidence crunch. Both are possible and as I said I’m not that bullish on gold prices for 2021 but the argument in favour of mid cap gold miners seems plausible to me, especially if despite extra money being thrown at exploration, big discoveries are becoming harder to monetise.