January 21, 2022
Gold rose 0.6% to US$1,839/oz this week, its highest level in over two months, as inflation continues to surge and the market is becoming concerned about whether the Fed will be aggressive enough to bring it back under control soon.
This week we look at gold's performance since November 2021 and see that it has been outperforming most other assets classes, ahead of equity, bonds, and alternative assets, and has only been marginally surpassed by commodities.
Gold rose 0.6% to US$1,839/oz this week, its highest level in nine weeks, as investors remain concerned about the Fed and other global central banks' ability to curb surging inflation this year. The December 2021 US CPI inflation reported last week spiked to thirty-eight-year highs of 7.12% yoy, well above the previous peak inflation just before the 2008-2009 global financial crisis at 5.31%. The inflation crisis is also not just a US issue, with European CPI inflation as of the most recently reported November 2021 data reaching 4.87% (Figure 4). While Japan has avoided inflation, with its CPI down -0.09% yoy in October 2021, it is a special case where there is structural deflation that has lasted for several decades, with drivers including a declining population. As this is very rare globally, we can assume that Japan is an exception and that inflation is becoming a widespread global phenomena.
Taking only a quick look at some recent headline numbers, we might expect a different outcome from the one that is currently arising for gold, equities and bonds. First, it might be expected that rising inflation would naturally drive investors into equities, with companies having the ability to hike their prices and keep up with the increasing CPI indices. Second, we might expect that with surging bond yields, that investors would be selling gold to move into equities. However, for equities, investors are likely more concerned that the recent inflation is going to drive the Fed to eventually aggressively raise rates, cutting the valuations all of stocks, and probably more than offsetting any advantage equities have as an inflation hedge. Coupling that with stock market valuations that are extremely high versus history, the probability that there could be a contraction in multiples in stocks seems reasonably high, leading many investors to start reducing equity exposure in recent months.
For bond yields and gold, their relationship is based more on real yields than nominal
ones. So, while nominal yields have indeed spiked over the past month, real yields,
which subtracts inflation from the nominal yield, are actually heavily negative currently.
For example, in December, the nominal US 10-year bond yield was 1.5% on average,
but with inflation at 7.12%, the real yield was -5.6%, and has declined consistently
over the past year from -0.3% in January 2021 (Figure 5). This means that investors
have not been losing anything by holding gold versus bonds, when inflation is taken
into consideration, with holding bonds actually a loss-making proposition.
We can see this relationship over time in Figures 6 and 7, which show the gold price versus the US 10-year real bond yield from 1968 to 2021. From 1968 through to 1973 the US was on the gold standard, and therefore the gold price was flat. However, it went off the gold standard in 1973, sending the real bond yield plunging to -4.66%, and driving up gold over four times to US$181/oz. Gold declined as real yields turned positive in the mid-1970s. Into the late 1970s and into 1980, real bond yields again went negative, to a low of -4.49%, and gold rose nearly sevenfold to US$675/oz.
However, the spike in real yields from 1981, reaching a peak of 9.39% in August 1983, sent gold down to below half its previous highs. As yields fell through 1987, gold again recovered, to peak at US$487/ounce, and then through the mid-1990s, both the moves in real yields and gold became much less volatile than they had been in the previous two decades. The lower volatility continued from the mid-1990s to the mid-2000s, with real yields positive, but gradually trending down, and gold rising. Gold hit a high of US$971/oz in March 2008, and the real yield hit a low of -1.42% in August 2008, just prior to the global financial crisis, which sent real yields spiking to 5.52%, on heavy deflation, while gold declined to US$756/oz in November 2008.
However, real rates were brought down through a massive monetary injection to lows
of -1.84% by August 2011, and gold peaked at US$1,781/oz in September 2011. As
the economy recovered through the mid-2010s, real yields picked up to over 2.0%,
and gold retreated to lows of US$1,096/oz in January 2016. Both real yields and gold
remained relatively flat from 2015-2018, but real yields had already started to slide
towards zero in 2019, sending gold up, before the global health crisis exacerbated
this trend, with the massive monetary stimulus in response driving negative yields
below 1970s levels, and a major spike in gold.
What all this history indicates is that big moves towards negative real yields tend be correlated with big rises in gold, and that the reverse is also true. What is interesting in recent months is that even as real yields have continued to plummet, gold has remained relatively flat. This suggests that the market may be expecting real yields to recover to some degree soon, possibly implying expectations that the Fed will intervene with rate hikes sooner than the current 2023 target. However, if the Fed does not make clear indications of moving forward on rate hikes or if inflation spikes further, this could potentially drive up gold. Overall we do not expect the Fed to be as aggressive this year as the market might be expecting, and that gold will be at least supported around current levels, if not see some gains.
Given the significant rise in volatility we are starting to see in global markets over the past two months, this week we look at gold's performance since November 2021 versus other classes, and even with it up just 2.8%, it is actually outpacing most of them. Starting with the major metals, gold has beat out copper, which gained 1.8% since November, and silver, up 0.7% (Figure 8). Given the situation outlined above, we expect to see gold at least hold up this year, as a combination of an inflation hedge and general safe haven. Of these three metals we are most concerned about copper, given our expectation that economic growth will ease, and this metal tends be strongly correlated with overall global economic growth. While a decline in the economic cycle could also hit silver, which has an industrially driven component, similar to copper, it also is driven by monetary factors, similar to gold, which we believe should be supportive. Also potentially boosting silver is that its historical ratio versus gold is low, and a reversion back towards its medium-term average could push up silver, given that we expect gold to at least hold up this year.
Gold has outperformed the equity markets, which seem to be indicating a rising in risk-off sentiment. Gold's 2.8% gains since November 2021 beat the S&P 500, a broad measure of the largest and generally strongest companies in the US, which declined -1.8% (Figure 9). However, gold has seen a much bigger outperformance versus the equity indices that tend to be weighted towards a higher degree of risky stocks. These include the Nasdaq, down -7.5%, with a heavy contribution from high growth tech stocks, many of which have only revenue, no earnings and very high valuations. Another is the Russell 2000, tracking US small caps, down -12.5%, suggesting that the riskier the stock, the more likely the market was to reduce their position in it in recent months.
While some gold stocks have felt pressure along with the rest of global markets, this has been mainly seen in the juniors, with the GDX ETF, a proxy for producing miners, actually slightly outperforming gold since November 2021, up 2.9% (Figure 10). Even for the juniors, the pressure has been limited, with the GDXJ ETF, a proxy for the performance of junior miners, down -1.7%, a better performance than even the S&P 500, and well ahead of the Nasdaq and Russell 200. This shows that the increase in gold price has been more than enough to offset the broader equity market pressure for the producing gold miners and significantly curbed the downside for the juniors compared to other risky equity sectors.
Often a move into gold and out of equity as part of a general risk-off sentiment might also be expected to drive a move into bonds, pushing down nominal bond yields. However, the recent shifts have seen investors selling bonds and nominal yields rising, as the market starts to price in rate hikes. At the same time, the surge in consumer prices is also reducing bond prices, as inflation reduces the value of their fixed nominal payments and principal, apart from the relatively small proportion of inflationlinked bonds. Global government bonds, measured by S&P's Global Sovereign Bond Index, declined -1.2% since November, and the riskier corporate bond sector, measured by the S&P International Corporate Bond Index, is down -1.7%, offering more support to the idea of a broader risk-off sentiment (Figure 11).
The US$ has held up reasonably well versus gold, up 1.0%, as it tends to be strong
during a risk-off period, as investors move more to cash in general, and also to the
US$ specifically, given its strength as the global reserve currency (Figure 12). The
commodities sector has continued to rise, up 3.1%, outpacing the gains in gold, likely
driven by ongoing price inflation and supply chain distortions. The property sector
has not seen a major decline, as measured by S&P's Global Property Index, down
just -1.5%, with property considered an inflation hedge. Other alternative classes
seem to have been hit by the recent risk-off sentiment, with private equity, measured
by the S&P Private Listed Equity index, down -7.0%, and cryptocurrency the worst
performer of any major asset class, with Bitcoin down -32.3%.
Overall, gold's performance since November 2021 has outperformed equities overall, far outpaced the riskier stock indices, surpassed the bond markets and the US$, and alternative asset classes including property, private equity and cryptocurrency. The only assets that have outperformed gold are the gold producers themselves, and the commodities sector overall, which have also been driven by inflation concerns. We expect that there is a significant probability that we could see this trend of gold outperformance versus other asset classes continue this year.
The producing gold miners were nearly all up on the rise in gold (Figure 13). Sector press releases this week have been mainly on preliminary Q4/21 production in advance of the upcoming quarterly results, with Barrick, Kirkland Lake, B2Gold, Alamos and Centerra all reporting, and Eldorado announced its five-year production guidance (Figure 15).
The Canadian juniors nearly all rose as gold picked up, offsetting the general pressure on riskier smaller cap stocks (Figure 14). For the Canadian juniors operating mainly domestically, New Found Gold reported assay results from the Golden Joint Zone of the Queensway project and Eskay released drilling results from its VMS project. Tudor Gold appointed Natalie Senger as Vice President of Resource Development and issued stock options and Pure Gold reported infill drilling results (Figure 16). For the Canadian juniors operating mainly internationally, Rupert released infill drilling results from the Ikkari zone and the Heina Central target at its Rupert Lapland project and Novo Resources and Mako Mining reported their Q4/21 production (Figure 17).
Disclaimer: This report is for informational use only and should not be used an alternative to the financial and legal advice of a qualified professional in business planning and investment. We do not represent that forecasts in this report will lead to a specific outcome or result, and are not liable in the event of any business action taken in whole or in part as a result of the contents of this report.