Blog 2 Columns

[This blog post is an excerpt from a commentary published at www.speculative-investor.com last week]

This is our annual reminder that gold mining stocks should always be viewed as short-term or intermediate-term trades, never as long-term investments. If you want to make a long-term investment in gold, then buy gold bullion.

The reason is illustrated by the following weekly chart. The chart shows more than 100 years of history of gold mining stocks relative to gold bullion, with gold mining stocks represented by the Barrons Gold Mining Index (BGMI) prior to 1995 and the HUI thereafter. The overarching message here is that gold mining stocks have been trending downward relative to gold bullion since 1968, that is, for 56 years and counting.

We’ve explained in the past that the multi-generational downward trend in the gold mining sector relative to gold is a function of the current monetary system and therefore almost certainly will continue for as long as the current monetary system remains in place. The crux of the matter is that as well as resulting in more mal-investment within the broad economy than the pre-1971 monetary system, the current monetary system results in more mal-investment within the gold mining sector.

The difference between the gold mining sector and most other parts of the economy is that the biggest booms in the gold mining sector (the periods when the bulk of the mal-investment occurs) generally coincide with busts in the broad economy, while the biggest busts in the gold mining sector generally coincide with booms in the broad economy. The developed world, including the US and much of Europe, entered the bust phase of the economic cycle in 2022 and the bust is not close to being over. This means that we are in the midst of a multi-year period when a boom should be underway in the gold mining sector.

To date, the gold sector’s upward trend from its 2022 low hasn’t had boom-like price action. The main reason is that the current economic bust is progressing more slowly than is typical, largely because of the efforts of the US government to boost economic activity via recession-like deficit spending and the parallel efforts of both the Treasury and the Fed to boost financial market liquidity. A related reason is that during the economic bust to date the broad stock market has performed unusually well. This has meant more competition for the attentions of speculators and investors. The gold sector has been generating good operating results and stock market performance, but so have many other sectors.

We expect that over the next 12 months the gold mining sector will continue to demonstrate strong earnings growth while most other sectors see flat or declining earnings as the economy slides into recession. This contrast should lead to boom-like price action in the gold sector. In fact, we think that the HUI could trade north of 600 next year while remaining in its long-term downward trend relative to gold bullion.

[This blog post is an excerpt from a recent commentary at www.speculative-investor.com]

Both Kamala Harris and Donald Trump are espousing policies that will be bearish for the US$ and bullish for gold. This means that regardless of what it turns out to be, the outcome of the November-2024 Presidential Election will be consistent with our view that the US dollar’s foreign exchange value will continue to trend downward and the US$ gold price will continue to trend upward for at least another 12 months. However, apart from having similar ramifications for the longer-term trends in the currency and gold markets, there are substantial differences between the candidates’ main policies. Let’s delve into some of the details.

Harris has talked about raising the capital gains tax rate and introducing a tax on unrealised capital gains to ensure that very wealthy taxpayers pay a minimum tax rate of 25%. If implemented, these changes would have the effect of reducing investment and therefore economic progress. Also, they would be a boon to the IRS and the private tax planning/reporting industry, because the additional complexity introduced by incorporating calculations of unrealised capital gains into taxable income would require substantial extra resources in both the government and the private sector. These extra resources wouldn’t just be non-productive, they would be counterproductive.

As an aside, when politicians introduce new taxes they usually make the assumption that the world will continue as before except with more money being paid to the government. However, taxes change behaviour, sometimes to the extent that new or increased taxes lead to a reduction in government revenue. This is exemplified by the fact that almost every country that has imposed a wealth tax has ended up scrapping the tax because it led to the exodus of capital, resulting in a weaker economy and lower revenue for the government. The reality is that while a promise to extract more money from the extremely wealthy can sound good to many voters, the wealthier a taxpayer the more mobile their wealth tends to be.

Although she has attempted to soften her stance on energy-related issues (for example, she claims to no longer favour a ban on fracking and she has stopped talking about the “Green New Deal” that she once supported), under a Harris regime it’s likely that, as part of a general increase in the amount of government regulation of business, it would be more difficult to get approvals for oil and gas projects. Also, it’s almost certain that the government would direct a lot more resources towards intermittent energy (sometimes called renewable energy). These actions would drive up the price of energy and increase the risk of energy shortages, with knock-on negative implications for the US economy.

Lastly, a Harris administration probably would prolong the Ukraine-Russia war, with devastating additional consequences for Ukraine — and potentially for all of Europe if the war is allowed to escalate — in terms of lives and infrastructure, as well as negative consequences for the US government’s budget deficit. A Trump administration, on the other hand, would be more likely to negotiate a settlement that ends the senseless destruction.

Trump is advocating lower taxes, which would be a plus if he were also advocating government spending cuts to offset the associated reduction in government revenue. However, it seems that no meaningful spending cuts are being considered. Therefore, the tax cuts would accelerate the rate of increase of the federal government’s debt, leading to higher interest rates and private-sector debt being ‘crowded out’ by government debt.

Trump also is advocating tariffs on all imports, with huge tariffs to be imposed on any imports from China. Furthermore, he has stated that he will use tariffs as a weapon against any country that acts in a way that he deems unacceptable, including against any country that attempts to move away from the US$-based international monetary system.

Tariffs that are imposed on US imports are paid by the US-based importers and would get passed on to US consumers, so an effect of the tariffs would be a sizable increase in the US cost of living. Another effect would involve the start of a process to change supply chains and relocate manufacturing in response to the sudden government-forced changes in costs. This process would be long and expensive.

There is no doubt that the Trump tariffs would lead to retaliation from other governments, with predictable effects being smaller markets and smaller profit margins for US companies exporting from the US or operating outside the US. Also, it’s likely that international trade blocs would form that excluded the US.

Most significantly from a long-term perspective, the tariffs and the threat to use tariffs as a weapon to punish governments deemed by the President to be recalcitrant would reduce the international demand for the US$ and could bring forward the demise of the current global monetary system (the Eurodollar System discussed in the 12th August Weekly Update). This is not primarily because the tariffs would lead to less international US$-denominated trading of goods and services, although they certainly would do that. Instead, it is because the non-US demand to hold US dollars is based on the US having large, liquid, open and secure markets. The US financial markets will remain large and liquid for the foreseeable future, but the international demand for the US$ will decline to the extent that these markets are no longer perceived to be open and secure.

The shift away from the US$ would occur over many years, because currently there is no alternative. However, the introduction of Trump’s tariffs would increase the urgency to establish an alternative and could have noticeable effects on the currency market as soon as next year.

By the way, although it was ineffective the Biden administration’s decision in 2022 to ban Russian banks from using the SWIFT system possibly was viewed as a ‘shot across the bow’ by many foreign governments, corporations and wealthy individuals. If Trump gets elected and does what he has said he will do with tariffs, it would be a ‘shot directly into the bow’.

Summarising the above, a Harris administration would attempt to establish higher tax rates, which would lead to reduced investment and a weaker US economy. Also, the price of energy would be higher, more resources would be directed towards inefficient sources of energy and the Ukraine-Russia war probably would either grind on or escalate. A Trump administration wouldn’t make these mistakes, but via aggressive and far-reaching tariffs it would raise the cost of living and throw the equivalent of a giant spanner into the international trading and investing works. One thing that Harris and Trump have in common is that their planned actions will ensure that the US government’s debt burden continues to increase at a rapid pace.

It’s almost as if both sides of the US political aisle have a weaker dollar and a higher gold price as unofficial goals.

The US yield curve is considered to be a good leading indicator of US recession, with an inversion of the curve invariably occurring prior to the start of a recession. However, the Wolf Street article posted HERE questions the yield curve’s reliability. The article notes that part of the US yield curve recently ‘uninverted’, which is true. What’s not true is the claim in the article that since 1998 the US yield curve failed twice by warning of recessions that didn’t occur.

According to the article, the yield curve’s 2019 inversion was a failure because even though there was a recession in 2020, the recession was the result of a pandemic and not a business cycle downturn. This is strange reasoning, to put it mildly.

The only way that you could argue logically that the yield curve’s 2019 inversion was a failure would be if you could re-run history to show that in the absence of the COVID pandemic there would not have been a recession. Since this is not possible, the 2019 inversion should not be viewed as a failure. Either it was a success or it should not be counted.

Also according to the article, there was a yield curve inversion in 1998 that was not followed by a recession.

The problem here stems from interpreting a multi-day spike into inversion territory as a recession signal. This problem goes away if you base your analysis on monthly closing or monthly average prices, which generally is what should be done with long-term indicators.

Here is a monthly chart showing that since the late-1960s every inversion of the US 10year-3month yield spread was followed by a recession. Consequently, if this cycle’s yield curve inversion does not lead to a recession then it will be the first failure of this type (the first false positive) in more than 50 years. Note, though, that the monthly chart of the 10year-3month yield spread shows that there was no yield curve inversion prior to the 1990 recession, so this could be viewed as a false negative.

Regardless of whether or not this cycle’s yield curve inversion leads to a recession, a yield curve inversion/uninversion clearly isn’t a useful trading signal. The time between the warning signal and the projected outcome is simply too long and too variable.

There are many problems with the calculation methodology of the Consumer Price Index (CPI) and with the whole concept of coming up with a single number to represent the purchasing power of money. Interestingly, however, if we calculate the inflation-adjusted (‘real’) gold price by dividing the nominal US$ gold price by the US CPI, which is what we have done on the following monthly chart, we see that the result has peaked at around the same level multiple times over the past 50 years and that the current value is around this level. Does this imply that gold’s upside is capped?

It adds to the reasons that we should be cautious about gold’s short-term prospects. These reasons include the size of the speculator net-long position in gold futures, the August-September cyclical turning-point window for the gold mining sector, the likelihood of a reduced pace of US federal government spending during the months following the November-2024 election, the fact that gold’s true fundamentals are not definitively bullish, the high level of the gold/GNX ratio (gold is expensive relative to commodities in general), the extent to which the financial markets have discounted Fed rate cuts (four 0.25% Fed rate cuts are priced-in for 2024, creating the potential for a negative surprise from the Fed), and the high combined value of gold and the S&P500 Index relative to the US money supply. However, we expect that within the next 12 months the gold/CPI ratio will move well into new high territory, mainly because:

1) The US economy finally will enter the recession that has been anticipated for almost two years and that has been delayed by aggressive government spending, leading to efforts by both the Federal Reserve and the federal government to stimulate economic activity.

2) Despite the rise in government bond yields over the past few years, it is clear that neither of the major US political parties nor their presidential candidates have any concern about the level of federal government indebtedness. Putting it another way, currently there is no political will to reduce government spending. On the contrary, both presidential candidates are going down the well-worn path of trying to buy the votes of influential groups while ‘turning a blind eye’ to the government’s debts and deficits.

3) Using our own method of adjusting for the effects of inflation*, which generally will not be accurate in the short-term but should be approximately correct over periods of several years or more, the current ‘real’ gold price is a long way below its 1980 and 2011 highs (our method indicates inflation-adjusted highs of around US$5000/oz in 1980 and US$3400/oz in 2011). Refer to the following monthly chart for more detail.

So, while the proximity of the gold/CPI ratio to its long-term resistance adds to the short-term risk, this resistance probably won’t act as a ceiling for much longer.

*The theory that we apply can be summarised as follows: The percentage reduction in a currency’s purchasing power should, over the long-term, be roughly equal to the percentage increase in its supply minus the percentage increase in the combination of population and productivity.

By our reckoning, during the first half of 2022 the US economy entered the bust phase of the economic boom-bust cycle caused by monetary inflation (rapid monetary inflation causes a boom that inevitably is followed by a bust as the receding monetary tide exposes the boom-time malinvestments). The bust phase almost always culminates in a recession, although it doesn’t have to.

So far, the performances of commodity prices in both US$ terms and gold terms are consistent with an economy in the bust phase, in that last week the GSCI Spot Commodity Index (GNX) tested its cycle low in US$ terms and made a new 3-year low in gold terms. The following daily chart shows GNX in gold terms, that is, it shows the commodity/gold ratio. Booms and busts are defined by the commodity/gold ratio, with booms being multi-year periods during which the commodity/gold ratio trends upward and busts being multi-year periods during which the commodity/gold ratio trends downward.

Note that it is not unusual for the stock market, as represented by the S&P500 Index (SPX), to trend upward for a considerable time after the start of an economic bust. For example, an economic bust started in October of 2018 but the SPX didn’t peak until February of 2020. Therefore, the fact that the SPX made a new all-time high as recently as last month is not inconsistent with the US being in the bust phase of the economic cycle.

What is inconsistent with the bust phase are credit spreads, which prior to the turmoil of the past 1.5 weeks were at their boom-time lows. However, the relatively low average level of US credit spreads does not mesh with the relatively large number of corporate bankruptcies, so it’s likely that credit spreads are sending a misleading signal.

The misleading signal could be the result of junk-rated corporations delaying their re-financings for as long as possible in the hope that if they wait long enough, they will be able to re-finance at lower interest rates during the next Fed rate-cutting cycle. The problem that many of these companies will encounter is that a Fed rate-cutting cycle probably will begin near the start of a recession and a multi-quarter period during which interest rates fall on high-quality debt while rising rapidly on low-quality debt.

In a blog post earlier this year we wrote that the conflict between the signal from the commodity/gold ratio and the signal from credit spreads would have to be resolved either by credit spreads widening substantially in response to evidence of economic weakness or by the prices of industrial commodities rising substantially in response to evidence that a new boom had been ignited. Our view then and now is that the former is by far the more likely outcome. In fact, there’s a good chance that last week’s rise in the credit-spreads indicator shown on the following daily chart marked an important turning point.

[This blog post is an excerpt from a recent commentary at www.speculative-investor.com]

In a blog post in February-2017, we discussed an age-old relationship between interest rates and prices. The following chart-based comparison of the T-Bond yield and the commodity/gold ratio is a pictorial representation of this relationship. At least, it was until about two years ago when a major divergence began to develop between two quantities that previously had been positively correlated. Does this mean that the age-old relationship no longer applies?

The answer is that the age-old relationship hasn’t changed. It can’t change, because it is firmly rooted in economic reality. What’s changed is that the following chart has stopped being a good way to depict the relationship.

The fundamental basis for the underlying relationship is what Keynesians call “Gibson’s Paradox”. We won’t revisit Gibson’s Paradox in this discussion except to point out that it was the name given to the observation that interest rates during the gold standard were highly correlated to wholesale prices but had little correlation to the rate of “inflation”. For a more thorough explanation, please refer to the above-linked blog post.

This excerpt from our blog post explains how the above chart relates to Gibson’s Paradox:

“The commodity/gold ratio is the price of a broad-based basket of commodities in gold terms. In essence, it is a wholesale price index using gold as the monetary measuring stick. Although gold is no longer money in the true meaning of the term (it is no longer the general medium of exchange), it is still primarily held for what can broadly be called ‘monetary purposes’ and in many respects it trades as if it were still money. According to the age-old relationship discussed above and labeled “Gibson’s Paradox” by a confused JM Keynes, the commodity/gold ratio should generally move in the same direction as risk-free interest rates.

The risk-free US interest rate that is least affected by the direct manipulation of the Fed is the yield on the 30-year T-Bond, so what we should see is a positive correlation between the commodity/gold ratio and the T-Bond yield. Or, looking at it from a different angle, what we should see is a positive correlation between the gold/commodity ratio and the T-Bond price. That’s exactly what we do see.”

Well, that was exactly what we WERE seeing until about two years ago, when the T-Bond yield began to trend upward in parallel with a downward trend in the commodity/gold ratio.

As stated near the start of this discussion, the age-old relationship between interest rates and prices (“Gibson’s Paradox”) hasn’t changed. Furthermore, the nature of gold hasn’t changed over the past two years, so the commodity/gold ratio still should be positively correlated with the risk-free interest rate, which, in turn, is determined by economy-wide time preference. What has changed is that the T-Bond yield has stopped being a good indicator of the risk-free long-term interest rate.

Looking from a different angle, the fact that the commodity/gold ratio has trended downward tells us that societal time preference (the determinant of the risk-free interest rate) has been falling, that is, that people are becoming more inclined to save and less inclined to spend. This is a global phenomenon, not a US phenomenon, but evidence in support of this can be found in the following chart of US retail sales. The chart shows that nominal (that is, not inflation-adjusted) US retail sales were only about 3.5% higher in May-2024 than they were two years’ earlier. Over the same period the US CPI rose by 7.5%, so in real terms the dollar value of US retail sales has fallen over the past two years.

The commodity/gold ratio tells us that the risk-free interest rate has fallen since the second quarter of 2022; however, the T-Bond yield is now much higher. This can’t be explained by rising inflation expectations, because the market prices of Treasury Inflation-Protected Securities (TIPS) tell us that inflation expectations have fallen since the second quarter of 2022.

The only way to explain the rise in government bond yields in the face of a falling risk-free interest rate and flat-to-lower inflation expectations is declining confidence in government and/or increasing fear that the rate of growth in the supply of government debt is going to become a major problem in the not-too-distant future. That is, trends in the T-Bond yield no longer reflect trends in the risk-free interest rate due to an expanding risk premium in the T-Bond yield associated with an increasingly profligate government. This, by the way, is one of the reasons why anyone who predicts that Treasury yields are going back to anywhere near their 2020 lows will be wrong.

We now have a market analysis challenge because there is no longer an indicator of the risk-free interest rate that is independent of the gold price. At least, we can’t identify one at the moment. We can use the commodity/gold ratio to provide information regarding the interest rate that underlies all other interest rates, but we don’t have a separate indicator of the risk-free interest rate that can be used to assess whether gold is too expensive or too cheap relative to commodities.

[This blog post is an excerpt from a recent commentary at www.speculative-investor.com]

With regard to the topics that we write about regularly, over the past year we have been most wrong about the stock market and the US economy. It’s true that the average stock has not fared particularly well, but we have been consistently surprised by the strength of the S&P500 Index and other large-cap-focussed indices for about 18 months now. Also, we thought that the US economy would be in recession by the end of last year and would be very weak during the first three quarters of this year, but while the US economy certainly slowed during the first half of this year it clearly has not yet entered recession territory. These mistakes are linked, in that major bearish trends in the stock market tend to encompass recessions. Today we’ll discuss, in broad-brush terms, a likely consequence of both the stock market and the US economy performing much better than we expected up until now.

In our opinion it’s not the case that the US economy has avoided a recession, but rather that the current cycle has been elongated.

We use the commodity/gold ratio (the Spot Commodity Index (GNX) divided by the US$ gold price) to define booms and busts, with booms being multi-year periods during which the ratio trends upward and busts being multi-year periods during which the ratio trends downward. The vertical lines drawn on the following GNX/gold chart mark the trend changes (shifts from boom to bust or vice versa) that have occurred since 2000.

It’s not essential that the bust phase of the cycle contains a recession, but it’s rare for a bust to end until a recession has occurred. Usually, the sequence is:

1) The commodity/gold ratio begins trending downward, marking the start of the economic bust period.

2) The economic weakness eventually becomes sufficiently pervasive and severe to qualify as a recession.

3) Near the end of the recession the commodity/gold ratio reverses upward, thus signalling the start of a boom.

Note that it is not unusual for the stock market to continue trending upward after the bust begins, but the stock market always peaks prior to a recession getting underway. For example, an economic bust began in October-2018 but the SPX continued to make new highs until early-2020.

In the current cycle the commodity/gold ratio has been trending downward since the first half of 2022, meaning that the US economy has been in the bust phase of the cycle for a little more than two years without entering recession. While this is much longer than average, it is comparable to what happened during 2005-2009. During 2005-2009, a bust began (the commodity/gold ratio commenced a multi-year downward trend) in Q4-2005, but a recession did not begin and the stock market did not peak until Q4-2007.

Evidence that the US economy is slowing is becoming clearer almost by the week, but a recession probably won’t start any sooner than September of this year and could be postponed, with help from the government and the Fed, until late this year or even early next year. This means that the coming recession probably won’t end any sooner than the second half of 2025 and could even extend into 2026, which has implications for all the financial markets. It’s the implication for the gold market that we are concerned with today.

The US$ gold price tends to peak on a multi-year basis after it has fully discounted the economic, fiscal and monetary consequences of a recession. This usually happens in the latter stages of a recession but before the recession has ended. Therefore, whereas a year ago we were thinking along the lines of the cyclical gold bull market climaxing in the second half of 2024, the current economic cycle’s elongation and the postponing of a recession probably mean that gold’s cyclical bull market will continue until at least the second half of next year.

[This blog post is a modified excerpt from a recent commentary published at www.speculative-investor.com]

The purpose of this piece is to address the misconception that the stocks of small, exploration-stage mining companies offer leveraged exposure to changes in metal prices. The reality is that they offer zero leverage to changes in metal prices. What they offer is leverage to changes in the general desire to speculate.

To explain, take the hypothetical example of a publicly-listed company that owns a project with a defined gold resource that it is attempting to grow via exploration. If everything goes well and the project can be drilled/engineered/permitted to the point where it makes sense to enter the mine construction phase, it most likely will be 5-10 years before the project is generating any revenue from gold production. Consequently, changes in the price of gold this year are irrelevant. What matters is what the price of gold and the cost of mining gold will be in 5-10 years’ time, which, of course, are complete unknowns.

The reason that the stocks of exploration-stage juniors are often viewed as providing leverage to metal prices is that the general desire to speculate tends to rise during upward price trends and fall during downward price trends. In particular, the further an upward price trend progresses, the greater will become the propensity for market participants to take risk in their efforts to profit from the trend. And consequently, the greater will become the popularity of relatively risky stocks.

“Market participants” in the above paragraph refers not only to the general public, but also to professional traders/investors and the managers of larger companies within the industry. Almost everyone gets more excited as the upward price trend matures, which is why a huge amount of money ends up being wasted (directed towards ill-conceived investments) during the latter stages of booms.

This also explains why many exploration-stage junior mining stocks do very little during the early and even the middle stages of upward trends in metal prices. A gold mining company that is more than 5 years away from producing gold, or more likely will never actually produce any gold, is not worth any more with a current gold price of $2500/oz than it would be with a current gold price of $1500/oz, because the current gold price is irrelevant to its valuation. It is the current producer, not the possible producer many years into the future, that can offer genuine leverage to changes in spot metal prices.

A related point is that if you own shares of a profitable gold producer then you have a stake in a real business, but if you own shares of an exploration-stage gold mining company then what you have is a stake in a story, not a real business. It’s important to understand what you own. If you own a stake in a real business then you potentially could make money from dividends, but if you own a stake in a story then you will only make money if other people become more bullish on the story and therefore become willing to buy you out at a higher price.

We expect that as the cyclical bull market in gold mining stocks becomes more obvious, the general desire to speculate in gold mining stocks will start to ramp up. However, the recent price action suggests that the start of the speculative ramp-up may still be at least a few months away.