Gold has been on a tear, adding over $300 per ounce over the last eight months, or nearly 22%. It’s now sitting at levels it hasn’t seen in nearly seven years.
The question is, how much further can we expect it to run?
We have seen spikes from the recent Iran drama, and a bit from the coronavirus scare as well. Headlines will always drive short increases, but fundamentals will carry the long-term trend.
Looking at those, it is clear that gold is far from done its run. Let’s dive in and take a look.
A classic way is to look at the relative price of gold to the Dow Jones Index. Here is a chart:
It now takes 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.
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.
Finally, 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 last year 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 factor in, 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.
The combination of historically low relative gold prices, low relative investor interest, and a coming windfall in gold miner profits all point to plenty of room for gold prices, and gold miner share prices, to run significantly higher.
In spite of the recent gains, we’re just getting started. Now is still a fantastic time to get in on the profits to come.
