In the past six months Bitcoin and the equity markets have been climbing, while gold has been falling. We look at what the driving factors are and why we think select gold stocks are looking good at current levels.
Gold is a hedge. It's not the only hedge.
Since cryptocurrency Bitcoin has moved closer to the mainstream, there is no question that plenty of money is going into Bitcoin which might have gone into gold.
The S&P/ASX All Ords is up 31% in the past 12 months while the gold price has been flat. Having climbed over US$2000 an ounce in August 2020 it performed as a hedge should during a volatile period. But then it’s been a downward slide to current levels of over US$1730 an ounce.
The price of 1 Bitcoin has gone from US$5k to US$60k in 18 months. While it could have legs and keep going, it could also turn out to be reminiscent of the words of the world’s first celebrity economist, Irving Fisher, who famously said 9 days before the 1929 crash: “Stock prices have reached what looks like a permanently high plateau.” As soon as the loudest sceptic on an asset class turns even vaguely neutral, that might spell the end of a particular speculative run.
While ETFs have made gold much more accessible to investors, the ability to buy the cryptocurrency on PayPal and other electronic payment apps has led to a surge in volumes being traded. This is not unconnected with the lack of interest in gold as a hedge.
Bitcoin has rapidly caught up in terms of value. The total cryptocurrency value represents US$2tn, of which Bitcoin is close to 55%. All the gold ever mined is worth in realm of US$5bn.
It hasn’t escaped us, however, that mining the last hundreds of thousands of Bitcoins use more electricity than Argentina. Some might say it’s not a very good use of resources. On the other hand, the damage wrought on the earth from gold mining is almost incalculable.
What Bitcoin doesn’t have is operating leverage. This can work both ways. While the gold price in US$ has fallen 10% in the past six months, or 15% in A$, Evolution Mining (EVN) has declined almost 30%.
Miners themselves have an operating leverage to the gold price. In a period of rising prices a listed mining company benefits disproportionately; when prices go the other way, as we’ve seen, the reverse occurs.
The stocks we will cover all show growing production, which mitigates this price decline. But there are significant risks associated with mining. Each mine has its risks, which is why we steer clear of single mine companies; while there is also sovereign risk outside of the company’s control, which is why we have in the main favoured Australian mining companies.
The interest rate factor
Interest rates create real competition, which is another reason why the gold price has weakened in the past six months. The US Treasury 10 year bond yield has climbed from 0.6% 12 months ago in the depths of the COVID-19 related panic to current levels of close to 1.7%.
This means that the cost to borrow non-yielding assets such as gold and Bitcoin has gone up; plus it has competition from a risk free yielding asset. Yields are now almost a real number.
Why hedging with a gold stock is a good idea right now
The question is whether yields are going up because of noninflationary economic growth or because inflation is a real possibility. We’re in a period of uncertainty, which is why you want a hedge.
The fact that the hedges can be volatile is why you only want them to be a small part of your portfolio in the region of 5-10%.
The market in hedges is always changing. If you believe that cryptocurrencies are an important part of the future then it might be worth a bet. But the point we’re making here is that a hedge is supposed to go the other way from the market; the market has gone up, so the gold price fall is not a surprise. Now might be the time for a re-allocation of your capital: taking from the one that’s done well and giving to the underperformer. Buying a good stock is very much a contrarian move.
Link between gold stocks and the gold price
It has been noted that gold stocks sometimes rise in anticipation of the actual gold price when it’s at a turning point.
Gold formed a base around US$1,680/oz on 8 March 2021 and after a brief rally revisited the US$1,680 level again on 30 March 2021 before rallying to around US$1,755/oz in early April. The gold price is now weakening. Will it continue to weaken or rise again?
Vaneck Vectors Gold Miners ETF is an ASX listed ETF (ASX code GDX) that seeks to replicate the price and yield performance of the NYSE Arca Gold Miners Index. It bottomed on 4 March 2021 and kept rising through gold’s weakness in late March. The same thing happened for the S&P/ASX All Ordinaries Gold Index (ASX code XGD), which bottomed on 5 March 2021.
What is interesting right now is that many of the better quality gold explorers and potential gold developers have recently broken long downtrends and their share prices are also rising. The rally is not just confined to companies that are currently gold producers.
It is still early days, but now seems the right time to have some gold exposure in the portfolio.
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