Ever since minutes of the April Federal Reserve meeting were released on May 18, it was straight downhill for the price of gold. The Fed’s apparent hawkishness raised fears of an interest rate hike as soon as June.
But the U.S. employment report released on June 3 was a shocker to the markets.
Only 38,000 jobs were added in May. That was the lowest number since September 2010. The number of Americans not in the workforce surged to a record 94.7 million, an increase of 664,000.
The dour jobs report realigned the market’s view of the Fed with what I have long been saying. My view is that Fed rate hikes are on indefinite hold.
Gold and Interest Rates
The obvious delay in any Fed rate hike was manna from heaven for gold. On Friday, gold prices surged more than $30 and settled at $1,243 an ounce.
Fears over the effect of interest rate hikes on gold were vastly overblown. Let’s just look at history.
Interest rates were rising in the late 1970s. That didn’t stop gold from rising to a then-record $850 an ounce. And the Fed raised rates from 1% in 2006 to 5.25% in 2006. Yet gold prices kept climbing.
The price of gold is much more dependent on other factors than interest rates. Many of these factors, at the moment, are quite positive for gold.
The Gold Bull Market
Let’s look at some factors that are currently adding luster to gold.
First, negative interest rates are a huge boost. There are now, incredibly, over $10 trillion worth of sovereign government bonds globally that trade with a negative yield.
Gold critics always pointed out that gold pays no interest or dividend. That’s still true, but that zero yield looks great in comparison to negative yields.
Next, demand for the precious metal was at its highest level ever in the first quarter of 2016. Demand was up 21% from the year-ago period. Central banks’ crazy actions are scaring investors. That makes gold more attractive.
And the list of “smart” investors moving into gold is impressive. It includes the likes of hedge fund giants Ray Dalio and Paul Singer. It also includes Stanley Druckenmiller. Though now retired, over a 30-year career Druckenmiller averaged a return of 30% annually.
Gold Miners Shine Even Brighter
Finally, the gold miners are way ahead in the cycle compared with other mining companies.
The cutbacks and efficiencies are already in place. Gold production has peaked for this cycle. Gold output from mines is expected to actually decline by 3% in 2016. And production is expected to drop by 15%-20% over the next three to four years. That is fabulous news for gold mining companies.
Even better news is the fact that all-in sustaining cash costs have fallen by a whopping 26%. All-in costs have gone from $1,265 per ounce in the third quarter of 2012 to just $936 per ounce in the fourth quarter of 2015.
Falling costs have been a huge boost to gold mining stocks. Shares of many gold miners have doubled this year from their beaten-down levels. The MSCI Global Gold Miners Index had trailed the MSCI World Index by 55% over the past decade.
The recent outperformance caught the eye of several well-known money managers.
George Soros owned $263.7 million worth of Barrick Gold Corp. (NYSE: ABX) as of the end of the first quarter. Soros may have been attracted by the fact that Barrick cut its debt by nearly a third over the past 15 months. It also knocked off 20% from its all-in costs.
David Einhorn, of Greenlight Capital, bought a 2.64% stake in the VanEck Vectors Gold Miners ETF (NYSEArca: GDX). He likely believes that the all-in costs for the entire sector will drop to below $900 an ounce this year.
More to Come
There should be more upside to come in the gold miners, benefiting Einhorn and others.
The ratio of gold equities to gold is less than half its historical average. Valuations are still hovering near the lowest they’ve been in 15 years. Compared to their gold reserves, miners are 19% cheaper than a year ago. And RBC thinks earnings at the large miners could double over the next two years.
All of which bodes well for the GDX fund. But if you’re willing to take more risk, the VanEck Vectors Junior Gold Miners ETF (NYSEArca: GDXJ) may be worth a look.
If you’re more risk adverse, consider the big royalties and streaming companies – Franco-Nevada Corp. (NYSE: FNV) and Royal Gold Inc. (NASDAQ: RGLD). These are good ways to participate in gold upside without the mining risk.
Or if you want to stick to just gold itself, a good choice is the VanEck Merk Gold Trust (NYSEArca: OUNZ). It allows investors to convert their shares into gold bullion or gold coins upon request.
How to Sleep Easy at Night
Is the economy keeping you up at night? Do you worry there’s another crash just around the corner? If so, you can stop worrying right now. All it takes is a few minutes.