SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE FED ACTS, CAPITAL MARKETS REACT, GOLD MINERS SHINE
The general equity market was up just a little in July as the investing world waited to see how aggressive the Fed would be in terms of lowering rates. When the cut in rates yesterday afternoon was only 25 basis points, all capital markets sold off, with his remarks interpreted as if this cut would be “one and done”. This will not be the actuality, in our opinion, as extended monetary ease will be necessary to support the weakening worldwide economy. It is encouraging to us that, with gold bullion virtually flat for the month of July, based upon the prices of GDX and GDXJ, the two largest gold mining ETFs, and TGLDX, OPGSX, AND INIVX, the three precious metal mutual funds that we track, the gold mining stocks were up about 5% for the month. This price performance is starting to reflect the inherent operating leverage within the miners vs. the price of gold bullion. For the year to date, the gold mining stocks are up about 24.1%, nicely outperforming gold bullion which is up 9.9%.
The price action of gold bullion and the gold mining stocks is beginning to attract attention, but ownership is still almost non-existent among North American investors. Many of the reasons provided by observers have some validity, but are nothing new to all of us. The monetary stimulus, the deficit, the debts, the geo-political risks, the political dysfunction, the increasing social unrest and the wealth gap are all continuing worldwide trends that have long been in place but are suddenly become newsworthy. It’s been said, in response to how a crisis develops: “very slowly and then very suddenly”. The following are a few of the most important reasons that precious metal holdings are all of a sudden performing well.
FUNDAMENTALLY: David Rosenberg, one of the most highly regarded investment strategists, and not a perennial “gold bug” by any means, just a couple of weeks ago, wrote “WHY GOLD HAS ALLURE”.
(1) The Fed is set to cut rates (as discussed above), which will send the fed funds rate into negative territory in real terms.
(2) Geopolitical risks, including Iran’s behavior, are increasingly bothersome.
3) Trade talks with China do not seem to be making progress, and Beijing has “tools” to hit back, including the ability to weaken their currency and/or continue reducing their US Treasury holdings.
(4) The economic war between the US and France is heating up, as Emmanuel Macron imposes a tax on American large cap tech companies. At the same time, trade tensions increase between the US and Japan, as well as South Korea.
(5) The Chinese economy, as well as the entire Asian economy, is clearly in retreat, adding to the prospect of worldwide monetary ease.
TECHNICALLY: In terms of supply of demand for physical gold, and the price charts:
(1) Central Banks around the world have continued their massive accumulation, a total of 374 tons in the first half of calendar ’19. While the first half total was down around 5% from ’18, the annualized rate of 750 tons is far more than in prior years. Russian and Chinese Central Banks continue their steady accumulation. India, between their central bank and their population, perennially the second largest accumulator of physical gold, imported 78 tons in May alone, running 49% ahead of a year earlier. Poland has now joined the other major buyers, buying a huge (for them) 100 tons in the second quarter alone. Sine the total annual worldwide production is about 3400 tons, these purchases are very meaningful.
(2) The price charts, for gold as well as gold mining shares, indicate much higher prices. Gold bullion has broken out to a five year high, though still 25% below the 2011 high. The gold mining shares are at three year highs but are still as much as 75% below their 2012 high.
The gold mining stocks are still substantially undervalued by many historical measures. Gold bullion, is down about 25% from its all time high of about 1900 in 2011, but GDX (the ETF with the larger miners) is down over 50% from its high and GDXJ (with the small to midsize miners) is down 75%. Our expectation is that gold bullion, will sell for a multiple of its current price and the mining stocks at a multiple of that. The timing, as always, is the big question, but the pieces seem to be falling into place, as outlined above.
In summary, there are never any certainties, especially in the short run, but it seems like both fundamental and technical considerations are in gear, and indicating much higher prices for precious metal securities.