Gold Rising Against All the Wrong Signals
Gold trades near $4,500. Silver has moved up. Gold stocks moved up. I am much more bullish today than 3 or 4 months ago.
The strongest signal is what gold did before today's rally. Until yesterday, gold rose in the face of a strong dollar, higher yields at 20-year highs, and higher oil. All three should push gold down. Gold rose anyway. That points to fundamental fragility in the system. The market may be pricing in some form of monetary easing before officials admit it - QE, yield curve control, or similar. These are different tools, but all are easing, and all are good for gold.
Gold has rallied since July 31st, when the US announced an intervention in the yen market. That signaled to markets that the Treasury was willing to cap the long end of the interest rate curve from rising. Higher rates hurt gold, so Treasury action to hold down long yields quietly strengthens gold.
Speculative Assets Keeping Pace
Silver has done as well as gold for the last month or more, and on some time frames silver has beaten gold. The junior miners (GDXJ) are keeping up with the larger miners (GDX). When the more speculative metal and the more speculative stocks match the conservative ones, that is a strong, healthy market. Both of these signs made me very bullish over the last month to six weeks. We have been buying heavily and there is not much money left.
Positioning Over Momentum
Should investors sell mining stocks or other equities to rotate into gold? It depends on existing exposure. A conservative client who bought a 20% gold allocation three years ago may now hold 35% to 40% in gold as prices rose. I would not sell conservative global equities to fund more gold in that case. An investor who is underweight gold needs to raise cash somewhere and get into gold and gold stocks now.
Is This a Dead Cat Bounce?
Some worry this is a false rally, like the pattern from 2011 into 2012 - a series of rallies into new lows during a bear market, or the fake rallies after gold's 1980 peak. Hindsight is always 2020.
How do we know February this year was not a major top? The real test is whether this is 2011 again or a genuine structural shift. In early 2011 you saw physical gold ETFs trading at premiums, and gold stock ETFs trading at rising premiums of 4% to 5% for four, five, or six months at a time. This year, though there were inflows into GDX and physical buying in China, there was no mania. The January-February inflow was nowhere near a flood of speculative money. Only in the last week have we seen huge inflows into GDX and GDXJ; go back one, two, or three months and flows are muted. Without the public participation and speculative fervor that always mark a major gold top, February was not the top. If that read is wrong, then this is a dead cat bounce - but there is no sign of the crowd piling in.
Treasury Debt Buybacks and Inflation
Would further Treasury debt buybacks accelerate inflation? Yes, they would be inflationary. The Treasury is buying back long-term debt but not reducing issuance at the short end, so the money supply keeps rising, which is inflationary by nature. A fiscally strong government with a surplus buying back long bonds - like a corporation buying back its debt - would be a sign of health. That is not the situation now. Buying back the long end while increasing short-end issuance is inflationary. Persistent inflation gives gold miners a structural tailwind beyond the bullion price.
What Drives Gold Stocks
GDX rose 9% in one session. Beyond interest rates and the gold price itself, the key drivers for gold stocks are flows and the health of the broad stock market. Flows are needed for the stocks to keep rising. A signal for larger retail and generalist inflows into the sector will come when the broad market turns over - miners can rise alongside a rising broad market, but generalist money often arrives only after traditional assets stop delivering.
The longer-term fundamentals are critical, especially fiscal deficits worldwide. Government debt keeps rising - not only in the US, but in Canada and Britain, which announced both higher unemployment and higher inflation on the same day. Deficits are not being tackled or brought under control across much of the developed world. As debt climbs, people look for an asset that protects against the loss of their currency's purchasing power. On a monthly basis, central banks and large buyers like Tether keep buying gold in increasing amounts. There was some selling in March tied to the conflict in Iran, but otherwise the buying continues.
The Miner Disconnect
There are real differences in this bull market. Gold rose meaningfully for years before gold stocks caught a bid, and even after they did, they showed no leverage until last year. Normally, 2 to 4 months after gold bottoms, gold stocks start rising two, three, or fourfold versus gold. That did not happen this time. Gold bottomed around the end of 2015, has climbed increasingly since 2022, and the gold stocks only really started moving last year.
Gold miners now have nine consecutive quarters of increasing free cash flow, with free cash flow rising dramatically and huge margins. I am surprised more institutional investors have not noticed. The second-largest gold miner - the best of the big miners - has all-in sustaining costs of $1,549 with gold over $4,000, giving incredible and unprecedented margins. That is a bizarre disconnect: bullion has advanced for years, yet miners only recently showed leverage and remain underappreciated. Improving cash generation should eventually force institutional recognition.
When Would Gold Fall Below $3,000?
For valuing miners, I would use a gold price of $3,000 - higher than almost anyone else uses. That assumes little chance gold retraces below $3,000 in today's environment.
What world would push gold below $3,000 in the next two years? Three things would have to happen. First, central banks decide they are full and stop buying. Second, various crises force central banks and others to use their gold for liquidity, as happened on a limited scale in February. Third, and most fundamental, governments around the world get their fiscal houses in order.
There is no sign of any of that. At some point we reach a breaking point - where long-term bonds of Britain, Germany, or the US do not sell, and governments have to postpone debt repayment. We are a long way from there. If governments were to restore fiscal credibility, that would change my view on the price of gold. Gold's downside depends less on optimism than on whether governments can actually fix their finances - and current policy points the other way.
