[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.

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

Gold is no longer money in the true meaning of the word*, but it still trades more like a currency than a consumable commodity and therefore should be analysed as a currency. In fact, in a currency hierarchy we would put gold at the top, then the US$, then a big drop to the euro, then another big drop the other major currencies. Consequently, it makes sense to analyse markets in gold terms as well as in terms of the US$ and other currencies, which is something we do regularly. For example, we pay close attention to the performances of the S&P500 Index (SPX) and the Spot Commodity Index (GNX) in gold terms. Now we are going to look at one aspect of the relationship between commodity prices in US$ terms and commodity prices in gold terms.

The following chart compares the general level of commodity prices in US$ terms (as represented by GNX) with the general level of commodity prices in gold terms (as represented by the GNX/gold ratio). The point we want to highlight today is that since 1995, GNX has made cycle lows in US$ terms and gold terms at the same time. These important lows are indicated by the vertical blue lines drawn on the chart.

Each of the lows in GNX and GNX/gold indicated by the vertical blue lines coincided with a recession and/or some form of debt crisis. Specifically, the April-2020 low coincided with the COVID crisis/recession, the January-2016 low coincided with the climax of the debt crisis in the US shale-oil sector, the late-2011 low coincided with the euro-zone sovereign debt crisis, the early-2009 low coincided with the climax of the Global Financial Crisis, the January-2007 low coincided with the climax of the initial phase of the US housing/mortgage bust, the early-2002 low coincided with the collapse of the dot.com equity bubble and the end of the 2001 recession, and the late-1998 low coincided with the climax of the Russian debt crisis and LTCM blow-up.

If past is prologue, then GNX won’t bottom in US$ terms until it has bottomed in gold terms. So, has GNX bottomed relative to gold?

As mentioned above, in the past the GNX/gold ratio has bottomed in parallel with a recession and/or some form of debt crisis, both of which are likely outcomes within the next 12 months but neither of which has happened during the current cycle. Therefore, there’s a good chance that the bottom for GNX still lies ahead and that the recent commodity rally is a countertrend move within an on-going cyclical decline.

*Money is defined by its function, not its physical characteristics. It is the general medium of exchange or a very commonly used medium of exchange within an economy. This means that if something is money it will be readily accepted by almost everybody in payment for goods, services, debts and assets. Other definitions have been concocted in an attempt to make the case that gold is still money, but all of these definitions are impractical.

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

In the 11th March Weekly Update we noted that the rise in the US$ gold price in the face of tight US monetary policy and high (by the standards of the past decade) real US interest rates implied concern about what’s likely to happen to the US$ in the future. We went on to write:

“At the moment this concern probably has more to do with the US government’s debt quantity spiralling out of control than the risk of the US economy entering recession in the near future. The underlying cause of concern, we suspect, is that the current administration appears to be willing to borrow/spend with complete abandon in its efforts to retain power, and there is no evidence that limiting the pace of government debt expansion is a priority on the other side of the political aisle.”

As an example of what was being done to boost his re-election prospects, we mentioned the $10,000 tax credit for first-time home buyers that had just been proposed by President Biden. Here are some additional examples from the past month:

1) A new rule has expanded the definition of a “Public Assistance Household”, which, in turn, expands the number of households eligible for Supplemental Security Income (SSI). The new rule will go into effect on 30th September-2024 (about one month prior to the election) and probably will increase the number of SSI recipients from 7.5M to more than 40M.

2) Government Sponsored Enterprise (GSE) Freddie Mac has put forward a proposal that would enable it to buy second lien mortgages. As explained in the article posted HERE:

“The aim is for Freddie to start buying fixed-rate second liens potentially by this summer, giving borrowers a way to tap an estimated $32 trillion of equity built up in U.S. homes in recent years. If approved, it would open the door for more borrowers to extract cash from their homes, without having to refinance at current 30-year fixed mortgage rates of about 7.2%.”

If Freddie Mac’s proposal goes ahead it could inject as much as $850B into the economy. If Fannie Mae, another GSE operating in the US home mortgage market, were to follow suit then the total amount injected could be close to $2 trillion. Therefore, this is potentially a very big deal.

3) Earlier this week President Biden announced large tariff increases on products imported from China. The tariff hikes, which include an increase from 27.5% to 102.5% (!!) on the tariff applied to China-made Electric Vehicles (EVs), are illustrated by the following graph from the Bloomberg article posted HERE.

Tariffs are paid by the buyers (ultimately US consumers in this case), not the sellers, so the main effect of this week’s tariff increases will be higher prices in the US for some products, especially products associated with the so-called “energy transition”. The hope, of course, is that even though the economic effects of this initiative probably will be negative, the optics will prove to be favourable. In other words, the hope is that the tariff change will create the general impression that the Administration is taking actions that will help the US economy even if the opposite is true. Unfortunately, there is also a lot of support for tariffs on the other side of the US political aisle.

All of the above actions will result in the popular measures of inflation (e.g. the CPI) being higher over the next couple of years than otherwise would be the case, but if it goes ahead the one that will have the biggest effect on the financial markets in both the short-term and the long-term is opening the door for GSEs to purchase second lien mortgages. As mentioned above, this could result in almost $2 trillion being injected into the US economy. The monetary injection would occur over a period of years, but if Freddie Mac’s proposal soon gets approved then the financial world will start discounting the likely effects immediately. The effects would be bearish for the US$ and bullish for most assets and commodities priced in US dollars, including gold.