Gold in Rally Mode, Investment Strategy


FLASH: The prospects of the Fed cutting interest rates to near Zero this year has gold rallying to 6 year highs.

Institutional investors like gold as a hedge against uncertain times, as gold has held value over centuries.

The Big Q1: But does it make sense for individual investors?

Here are some Key things to consider when deciding when, whether and how to invest in gold, either via gold stocks, such as Barrick Gold (GOLD) and Newmont Goldcorp (NEM), or gold ETFs.

Gold Investing Options: Gold Stocks And Gold ETFs

Gold stocks and gold ETFs are the simplest way for individual investors to bet on a rising gold price. Investing in gold stocks can be a riskier, but also potentially more rewarding, way of investing in the precious Yellow metal.

Investors have 3 major options, as follows:

  • They can buy gold stocks individually,
  • They can buy an ETF that tracks the gold-mining stock sector, such as the VanEck Vectors Gold Miners ETF (GDX), and
  • They can get direct exposure to the precious metal itself via the SPDR Gold Shares ETF(GLD).

Well-known gold mining stocks include Barrick Gold, Newmont, and Royal Gold (RGLD) You can find the Top gold-mining stocks, which are part of the broader Mining-Gold/Silver/Gems industry group, at IBD Stock Checkup.

In a sense, investing in gold stocks or a gold-mining ETF is a leveraged bet that the price of gold will keep rising. That is because a higher gold price can have a dramatic impact on the profitability of gold miners. For example, Newmont said its total cost of production amounted to $907 per ounce of gold in Q-1 of Y 2019. That meant increases in the price of gold above that level would go straight to the bottom line.

Investing in gold-mining stocks, especially a specific stock, brings in more complications than investing in the precious metal itself. The companies can suffer accidents or production snafus, deplete their reserves or pile up debt. On the upside, companies can increase mine output, find new reserves, or generate cost savings via mergers or mining productivity gains.

Gold Price History and Real Interest Rates

Adjusted for inflation, the price of gold hit an all-time peak in early 1980 amid double-digit inflation in the US.

Unadjusted for inflation, the gold price peak above $1,900 oz came in August 2011. That came in the wake of the great financial crisis. The Fed was engaged in its second round of QE (quantitative easing), the 2-year Treasury yield hit historic lows below 0.2%, and .DXY was not far off historic lows after a fight over the debt ceiling nearly led to a US debt default.

The gold price low of recent decades was just above $250 oz in Y 1999. That came as the US economy was still enjoying the upside of the dot-com bubble and productivity was booming.

The common thread linking gold price highs and lows seems to be real interest rates. In Y 1980 and again in Y 2011, real interest rates were negative, with 2-year Treasury yields well below the rate of inflation.

In Y 1999, as the price of gold slumped, real interest rates were on the rise. The Fed was in a rate-hiking cycle, raising its benchmark rate north of 5%, well above roughly 2% inflation.

The Big Q: Why do real interest rates matter so much for the price of gold?

The Big A: Gold is a store of value, but holding it comes with an opportunity cost. That money could instead be invested safely in Treasuries, for example. If real interest rates are attractive, holding gold is much less attractive. When real interest rates turn negative, holding gold is usually a winner.

But real interest rates are not the only determinant of the price of gold. The supply-demand balance is among other important factors.

For example, central bank sales of gold exacerbated the Y 1999 gold price slump.

How Gold Stocks Perform Vs The Price Of Gold

In general, if you think gold is near a bottom and has room to run, history would say you are better off owning gold stocks than the precious Yellow metal itself. If you think gold could be nearing a Top, you are probably better off holding gold than gold stocks, based on past performance.

Consider, from the gold price bottom in late Y 2015 through June 2019, the SPDR Gold Shares ETF tracking the commodity’s price rose 31%. Meanwhile, the VanEck Vectors Gold Miners ETF rose 93% over the same frame. That reflects the dramatic corporate earnings improvement thanks to the higher price of gold. Improved earnings, in turn, allow mining companies to increase dividends as the price of gold rises.

Newmont Mining stock and Barrick Gold stock have hit 52-wk highs, while Royal Gold stock has spiked to record levels, with big rallies over the past 2 months.

Yet the descent for gold mining stocks from the Y 2011 price high was much rougher than for the metal. To the trough in late Y 2015, the gold-tracking ETF tumbled 46%, but the ETF tracking gold miners cratered close to 80%.

The Gold Stock And Gold Price Outlook

The drop in real interest rates due to an abrupt pivot from the Fed has largely explained the rise in the price of gold in December 2018 and in 1-H of Y 2019.

The Fed decided that too little inflation was a bigger threat than too much inflation. Instead of hiking rates, policymakers are moving toward Fed rate cuts, perhaps a half-point cut on 31 July. If that persists, real interest rates should remain ultra-low, providing a positive backdrop for the price of gold.

The strength of USD also may have an impact on gold prices. Since it is priced in dollars, gold will tend to rise if USD weakens Vsinternational currencies. A weaker USD would not be a surprise as US growth slows.

Some who see gold as a good long-term investment point to US debt dynamics. Spiraling federal deficits and surging debt levels could force the Fed’s hand. In other words, the Fed might have to keep interest rates low or monetize the debt to avoid a fiscal crisis. That could erode the USD’s role as the world’s reserve currency.

So, no matter your view of whether the price of gold is a good bet, it makes sense to subject investment decisions in gold stocks or an ETF tracking gold or gold stocks, to the same process as regular stock buys. That means waiting for a proper buy point and a buy signal.

HeffX-LTN’s overall technical outlook for GLD is Bullish to Very Bullish at the week ended 19 July 2019.

Have a terrific weekend.