Moussa81
Introduction
It’s time to talk about gold, the precious metal that has been an increasingly hot topic since the pandemic.
Looking at global Google searches for “gold,” we see that searches have been consistently elevated since early 2020, with the first signs of upside momentum in the second half of 2019.
Google Trends
We’re seeing that this has also translated into a stronger performance of gold.
Using the SPDR Gold Shares ETF (GLD) as a proxy for gold, we see the relative performance against the S&P 500 (including dividends) bottomed in 2022.
Please note that the chart above shows the ratio between GLD and the S&P 500. Prior to 2022, the shiny metal has consistently underperformed the market.
In fact, over the past ten years, gold has returned just 71%, lagging the S&P 500’s 233% return by a huge margin.
Now, this seems to be changing, as gold is hot again.
COMEX gold futures are up more than 13% year-to-date, trading north of $2,300 per troy ounce.
TradingView – COMEX Gold
As one can imagine, this is highly beneficial for the miners who produce this metal.
My most recent article on the VanEck Gold Miners ETF (NYSEARCA:GDX) was written on October 13, 2023, when I went with the title “Buy GDX Before It’s Too Late.”
Since then, GDX has returned 19%. Although the S&P 500 has returned 20%, there’s a case to be made that underappreciated miners have more room to run, potentially outperforming the market.
Hence, in this article, I will explain why I believe that is the case.
So, let’s get to it!
Gold Has Become A Highly Attractive Commodity
Gold is a tricky asset – very tricky.
One of the things that makes it so hard to analyze is the fact that its main uses are not key in the economy. Unlike a metal like copper, which is used in construction and so many other uses, gold is mainly used for jewelry, investments (bars, coins, and ETFs), and central bank holdings.
ResearchGate![Gold uses (average over the last 10 years).Source: Authors' own elaboration, with data from the World Gold Council [12].](https://www.researchgate.net/publication/349449532/figure/fig1/AS:993103678820353@1613785776404/Gold-uses-average-over-the-last-10-yearsSource-Authors-own-elaboration-with-data.jpg)
Just 8% is used in technology/industrial markets, which has implications for gold.
After all, this essentially means that it’s a zero-yielding competitor of the dollar – an investment that cannot be “printed” and stored for eternity.
In my prior article on GDX, I used the chart below, which shows the highly correlated (inverse) relationship between gold and future rate expectations.
As we can see, once the market expects future rates to fall, gold prices start to rise. After all, it’s an “alternative” for the U.S. Dollar with a zero yield. Once the yield on the dollar decreases, gold becomes relatively more attractive.
CME Group (Not Updated)
Hence, this is what I wrote in the takeaway of my prior article:
The gold market’s dynamics have shifted, and the previously anticipated Fed pivot hasn’t materialized.
This has affected gold miners, now trading well below their highs.
The key factor influencing their trajectory is interest rate expectations. As rates are predicted to rise, gold faces challenges, but a potential future Fed rate cut could boost gold and miners.
As it turns out, the bull case is even stronger than that, as we are dealing with two factors:
- Inflation is higher than expected.
Looking at the chart below, the all-item inflation rate in the United States (the red line) has ended its downtrend in June 2023. Since then, inflation has gone sideways. Even worse, inflation has come in higher than expected for three consecutive months. Moreover, oil prices are breaking out, which is why I added the price of NYMEX WTI to the chart below.
TradingView (U.S. Inflation, NYMEX WTI)
Usually, an uptick in inflation is not necessarily bullish for gold because it should lead to higher interest rates down the road.
While I am in the “higher for longer” camp when it comes to both inflation and rates, gold is likely doing so well because the Fed isn’t willing to be more hawkish just yet. That’s reason two.
- The Fed is not as hawkish as some might expect it to be.
Bloomberg
As reported by Bloomberg (emphasis added):
Powell said recent inflation figures — though higher than expected — didn’t “materially change” the overall picture, according to his Wednesday speech at California’s Stanford University. He signaled policymakers will wait for clearer signs of lower inflation before cutting interest rates. Lower rates are generally positive for gold since it pays no interest.
I believe the Fed could be forced into a situation where it needs to choose between protecting the economy if debt quality deteriorates too much – even if inflation is still above its target.
This would be highly bullish for gold.
Moreover, central banks have accelerated gold purchases, which is also seen as a bullish signal, although I disagree with the thesis that the dollar may lose its reserve currency status.
[…] UBS pointed to rising gold purchases by central banks worldwide, which they said have reached the highest levels since the 1960s at more than 1,000 metric tons in each of the past two years. These bets by central banks could be seen as hedges against the dollar as a reserve currency. Especially coming from nations such as China, they could also represent precautions against future sanctions, in anticipation of still more geopolitical disruption. – Wall Street Journal
This brings me to gold miners.
It’s Time For Miners To Shine
There are many ways to invest in gold. One of them is buying the miners that produce it.
However, these miners have been horrible long-term investments.
Since 2006, the gold mining ETF GDX has returned 5% – including dividends. During this period, the price of gold has more than tripled.
According to a Bloomberg article from April 5 (emphasis added):
The faltering equities have turned the industry orthodox of producers outperforming the underlying commodity on its head, baffling observers.
“I’ve never seen it dislocate quite like this,” said Peter Grosskopf, chairman of SCP Resources Finance LP and former chief executive officer of Sprott Inc.
On top of geopolitical risks, mining companies have to deal with the risks of rising costs. Moreover, sometimes elevated debt levels and stock offerings to fund operations are a reason why the metal has outperformed its miners.
Adding to that, some miners have a history of ill-placed hedges, costing them billions in missed profits.
This underperformance has continued this year. Year-to-date, GDX is up 9%, underperforming the GLD ETF by roughly 3.4 points.
The good news is that the gap is closing. As we can see above, GDX had a much worse performance until it started to gain momentum in March.
I expect this to continue.
To show you why, we can use the chart below.
The red line shows the price of COMEX gold. The black line displays the ratio between the GDX ETF and COMEX gold. As we can see, gold miners underperformed gold when gold prices were weakening between mid-2020 and the end of 2022. However, they kept underperforming gold when the yellow metal started to rally.
TradingView (GDX/Gold Ratio, Gold)
The good news is that the relative performance has potentially bottomed, making it likely that the market is seeing value in gold miners after the recent divergence.
Especially if we see a bigger deterioration in credit quality or economic stability, I expect investors to start allocating (more) money to gold miners.
We are now close to four years of underperforming gold miners in an environment that is increasingly bullish for gold.
Adding to that, although I’m not a huge fan of technical analysis, we see that the GDX ETF is breaking out, which could be highly favorable for upside momentum, given its poor (relative) performance since 2020.
TradingView (GDX)
All things considered, I currently own Kinross Gold Corp. (KGC), Newmont Mining (NEM), and Agnico Eagle Mines (AEM). I am not long GDX, as I prefer buying single-stocks.
I have these positions in my trading account. However, I’m considering closing these investments to move the cash over to my dividend growth portfolio, where I aim to buy the Franco-Nevada Corporation (FNV), which I discussed in this article.
That said, GDX is not just a great benchmark for miners but also a great ETF to buy diversified mining exposure.
With an expense ratio of 0.51%, the ETF replicates the performance of the NYSE Arca Gold Miners Index.
Incepted in 2006, GDX is overweight in some of the world’s largest mines, including Newmont (11.5% weighting), Barrick Gold (GOLD), Agnico Eagle Mines, Franco-Nevada, and Wheaton Precious Metals (WPM).
VanEck
This also means that it owns both miners and streaming companies like FNV and MPW that have highly attractive margins.
Meanwhile, 41% of the ETF’s assets are in Canadian-based miners. The U.S. follows with 17% exposure. Australia has 12% exposure.
VanEck
All things considered, I stick to a Strong Buy rating and believe that the risk/reward for GDX remains highly attractive.
I also do not rule out more M&A in the sector if gold prices continue to rise.
Takeaway
The resurgence of gold presents an attractive opportunity for investors.
With growing global interest and shifting market dynamics, investing in gold miners like the VanEck Gold Miners ETF could yield significant returns.
As central banks increase gold purchases and inflationary pressures rise again, the potential for gold miners to outperform is looking very promising.
Despite past challenges, recent trends suggest a favorable outlook for the sector, making GDX a compelling (albeit volatile) investment choice.
The biggest risk to the thesis is a prolonged decline in gold prices, which could be triggered by elevated rates on a long-term basis. This would make the dollar relatively more attractive compared to gold and its miners.
