Gold prices just soared through the $1,600-per-ounce level even with some strong manufacturing data being dropped on the markets this morning.
All this comes on the heels of a great 2019 as well, at least the end of it.
The beginning of 2019 saw gold at $1,281 per ounce. By the end of the year it was up to $1,509 per ounce — a 17.8% gain.
Just a month later at the end of January 2020, it was up to $1,583 per ounce, pushing gains up to 23.5% That was enough to beat the huge gain we saw in the Dow Jones Industrial Average over the same 13-month period.
The question is, can we expect gold prices to keep heading up and, if so, how much further can we expect them to run?
We have already seen spikes from geopolitical dramas and stand-offs, the coronavirus scare, and plenty of other events as well. Headlines will always drive short-term increases which tend to quickly fade away, but fundamentals will carry the long-term trend.
Looking at the fundamentals, there is a strong case that gold is far from done its run in 2020. Let’s dive in and take a look.
Gold Versus the Dollar
Gold historically has been closely tied to the relative buying power of the U.S. dollar as the de facto global currency.
A whole lot of factors weigh into the important relationship between gold and the dollar as a result with the inflation rate being a primary driver.
The price for gold has increased rapidly, but when adjusted for inflation, the purchasing power of an ounce of gold was actually significantly higher in 1980 than it is today, or at the all-time highs nine years ago.
Gold would have to be at nearly $2,000 per ounce to match the purchasing power of an ounce back then.
Gold, for our purposes, is an investment. As such, we should give a lot of weight to the price of gold compared to other broad investment metrics as well.
Another way to look at it is this — gold is competing with other investments only for dollars that people are willing to invest.
Gold Versus Investments
That brings us to another classic way to look at the relative price of gold to the Dow Jones Index. Here is a chart:
Going into this year it took about 18 ounces of gold to match the “price” of the Dow. The peak of the gold-to-Dow ratio came back in 1999. Gold was around $290 an ounce and the Dow was around 11,500.
The low point came at the top of the 1980s commodities boom when gold was about on par with the Dow after a decade-long stretch of stagnant markets.
A ratio of 18 makes it clear that we’re not close to gold being relatively expensive. This is especially true with the upward pressure gold is seeing.
Another more modern way of looking at this is to look at ETFs, which trend really well with general investor sentiment.
Back in 2011 when gold peaked around $1,900 per ounce, the SPDR Gold ETF was the same size as the ever-popular S&P 500 ETF. It bottomed out at less than 10% the size and is now at a bit above 14%.
Precious metal mutual funds have also had a decade their managers would like to forget. According to data from Morningstar, on average they’ve fallen 5% per year.
Even with the rise in gold prices, investors clearly aren’t investing in gold at anywhere near the same level even though gold prices have advanced significantly towards their all-time highs.
This kind of delayed reaction is normal for all kinds of investments as they rebound. As investors reinflate fund sizes by moving into gold, we can expect significant price increases to overcome the lag they’ve seen compared to recent gold price gains.
Gold Mining Stocks
No talk of gold prices and investments should ignore a key feature of gold mining stocks — what is effectively a leveraged play.
All gold miners have a break-even point where their cost to produce gold matches their revenues. Dip below that, like we’ve seen in recent years, and it can turn into a bloodbath. Look back just a couple years and we can see plenty of evidence of that, with debt blowing up and causing drastic changes for even the major gold producers.
We’re entering a period where that has reversed and gold prices actually create a profit multiplier.
In 2019, the average all-in sustaining costs of mining for gold miners rose to $1,000 per ounce. A company with that average cost in June of 2019 would have the potential to make $273 per ounce of gold. At $1,600, the same company can make $600.
While gold went up about 22% over the same time period, the money the company can make selling the same ounce of gold went up 120%.
Gold companies rarely sell anything at spot prices. Long-term contracts and other costs dictate their “wholesale” prices, but also get rewritten.
Sustained higher gold prices will be trickling into projections and negotiations in coming quarters and are going to make the best gold miners cash-printing machines.
Gold Miner Reserves
Finally, we should look at long-term cannibalization of reserves while we’re at it.
Gold producers are facing an existential crisis without massive investments in exploration or the companies that are finding the best new deposits.
It takes a good decade on average of further drilling and development to get a new gold mine up and running and that average is only increasing.
Knowing that, take a look at where we were 10 years ago and what comes next. We’re poised to enter a multi-year period where gold producers will continue to deplete resources at an alarming rate without mergers or acquisitions.
This will create a squeeze on supply as demand is increasing while increasing the premium the major gold producers will have to pay to acquire smaller companies. It’s a one-two punch.
We’re already seeing a rise in M&A activity in the sector with large premiums. We’re about to see a whole lot more.
2020 is looking to be a volatile year. Economic data is mixed. Stocks are expensive. Politics in an election year will only make things worse.
That makes gold a strong candidate as both a safe haven and as an investment with a lot of catalysts and factors that will push prices higher. Make sure you’re positioned to take advantage.
