It seems like an eternity since the bull run in the gold market from 2000 to 2011. During those eleven years, the price of gold went up over six-fold, providing those that got in early with impressive returns that beat the stock market. It was an outstanding decade, as countries, institutions, and savvy investors who saw a crisis coming piled into the metal.
But since then, the price of gold has been stuck in the doldrums. It came down from its 2011 peak of nearly $2,000 per ounce and has hovered around the $1,200 to $1,400 range ever since, with a few blips here and there. Gold seemed like a great investment when people thought the world was coming to an end on the eve of the financial crisis. But with the economies of the world recovering, and the second-longest running economic expansion in history in the US, capital flows have gone elsewhere. Who would buy gold when you can own productive assets?
Gold miners have had a tough decade. For those of you that don’t know, profits in the gold mining world depend on the price of gold. Gold miners get gold out of the ground and sell it at the market rate to make their money. If the price of gold falls too much, it’s just not worth opening mines to get the stuff out. It’s too expensive.
With the price of gold staying put, gold mining stocks have also performed relatively poorly. Yes, gold miners are still in business and doing well in places like South Africa, but there’s a general sense that the stocks are about as valuable as they’ll ever be. Most people in the mainstream don’t see gold going higher. And if gold doesn’t go higher, mining stocks won’t either.
Of course, which way mining stocks will go all depends on your view of the future. If the future is uncertain, you’d expect investors to pile into safe-haven assets, like gold. Whereas if the future is bright, then investors would be wise to ignore gold altogether.
It’s interesting what’s happened recently: major financial institutions have said that they expect a recession in 2020 – at least in the US. If that’s the case, then the current boost in gold prices is to be expected. Productive assets, like equities, are unlikely to be as valuable in a contracting economy as profits are squeezed, and so investors will shift their portfolios. But is a recession coming?
The main argument for a recession right now seems to be that recessions have happened before. In the West, we’re used to a big recession every ten years or so – it just seems to be how the economy works. But if you look at all of those recessions individually, you soon realize that they were all specific events, not necessarily part of some grand cycle. The oil shocks of the 1970s caused slowdowns, but that had to do with the particular economics of the oil market at that time – and the relative dependence of some economies on oil. What if those shocks had never happened? Would we have had two decades of uninterrupted economic expansion in the 1960s and 1970s?
Likewise, the financial crises of 1991 and 2008 were also both avoidable, in theory. If banks hadn’t overextended themselves with experimental financial products, then they may have been able to cope with contractions in demand and inflated house prices.
The future doesn’t depend exclusively on the past. That’s the theory here, anyway. And so there’s no reason to expect a recession to arrive, like clockwork, sometime in 2020. It could, but it isn’t guaranteed.
Not knowing whether a recession is coming is one of the reasons it’s so hard to judge fair value for mining stocks. It makes sense to buy them if a recession is on the way. But it doesn’t make sense at all if not. Are there any other indicators that we can look at?
Mining Stocks And Recession
The value of mining stocks depends a lot on the probability of recession. But judging the arrival of a recession is notoriously tricky, as we’ve discussed. Working out whether a downturn in on the way 18 months out is almost impossible because leading indicators are not correlated with a fall in output over that time horizon. However, as the recession nears, some metrics do change and signal the possibility of an impending contraction.
People interested in buying mining stocks need to keep a close eye on these indicators – things like new car sales, consumer sentiment, and business confidence. If all of these are in the expansion zone, the economic output is unlikely to dip rapidly in the future. If, however, some of these indicators aren’t faring so well, then it could mean a recession is on the way.
The creators of the website Econ Pi have tried to create a tool using economic indicators to predict recessions. Their tool has predictive power when applied retrospectively to previous recessions. Using a collection of about fifteen indicators, the creators show that when the average position of all those indicators gets to a specific zone, the economy falls into recession within six months. We’re nowhere near that point yet, but over the last few months, we’ve been moving towards it. Weakness in the manufacturing sector is driving the move which could become worse if interest rates continue to rise.
There is a reason we might not see recession for a while: technological change. Unlike during the dot com boom when technological change drove stock prices to unsustainable highs, today’s technology is mature and delivering. We really are seeing the emergence of a range of economically-beneficial technologies on a broad set of fronts which could transform the economy. Mckinsey and other investment agencies like ARK, are predicting that thanks to new digital technologies, productivity growth could double over the next two decades from 2 to 4 percent per year. Artificial intelligence, genetic research, and automation could lead to a boom and renewed interest in equities.
The Mining Sector
Mining companies aren’t the only investment that people can make related to gold (and other precious metal investments). Investors would be wise to look into ancillary mining services too: for example, a mining powertrain service center. As demand for gold, silver, and other precious metals rises (if investors are spooked), so too will the value of these companies, just as Nvidia hit highs during 2017 thanks to demand from crypto miners for its GPUs.
Mining investors also need to keep a close eye on the value of the dollar. The current dollar strength is working against rises in the gold price in the US. The gold price relative to the price of other currencies, however, is going up. Mining stocks in places outside of the US, like Latin America, might be a good place to put one’s money. Canadian firms are also doing well by selling gold outside the US market.
Investors still need to be careful, though, even if they expect the price of precious metals to skyrocket. Not all mining companies are the same. Although most are solvent, some have shaky valance sheets, thanks to decades of massive borrowing and capital investment. When researching a company, always search through the balance sheet to find current assets and liabilities. Look carefully at this column to see whether the company has enough assets in cash to pay off any debts coming due. Remember, if a company cannot meet its debt obligations, it could be forced to shut down, wiping out any investor equity in the process.
It’s also worth looking at the effect that certain price changes have on the gold mining sector. Say for instance that the cost of getting an ounce of gold out of the ground is $1,100. If the price of gold rises from $400 to $1,000 – a huge move – it won’t make much difference to the mining sector at all because they’ll still make a loss if they decide to mine. Instead of losing $700 per ounce of gold they dig out of the ground, they lose $100. But it’s an entirely different story if the price of gold goes from $1,000 to $1,300. At $1,300, miners get $200 for each ounce they sell on the open market, opening up opportunities for profit.
Are gold miners looking at a rosy future? If history is any guide, then the answer has to be yes. We’re nearly ten years into an economic expansion, the second longest in modern history. Many commentators say that with the US-China trade war and a slowing economy, that the end is in sight. But the question for savvy investors is, “is it?”
If the answer is no, then investors should shy away from putting their money into the mining sector: it’s likely to remain stagnant for a while. But if the price of gold does shoot up, they could make a killing. Miners are currently dirt cheap.
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