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

The HUI peaked at over 600 way back in 2011 with the gold price about $100 lower than it is today. However, this provides no information whatsoever regarding the HUI’s current value or upside potential. The reason is that the average cost of mining gold is much higher now than it was in 2011. Due to the ever-increasing cost of mining gold, over time it takes a progressively higher gold price to justify the same level for the HUI. Putting it another way, due to the increasing costs of mining gold and building new gold mines, the price of the average gold mining share is in a long-term downward trend relative to the price of gold. An implication is that the HUI isn’t necessarily cheap today just because it happens to be more than 60% below its 2011 level.

Over periods of two years or less, however, the ratio of a gold mining index such as the HUI to the price of gold bullion can be indicative of whether gold stocks are cheap or expensive. This is because the average cost of mining gold usually doesn’t change by a lot over periods of less than two years.

The following daily chart of the HUI/gold ratio suggests that at the moment they are cheap. In particular, the chart shows that at the end of last week the HUI/gold ratio was near the bottom of its 2-year range — very close to where it bottomed in September-2022 and October-November-2023.

This doesn’t mean that a substantial rally is about to begin. On the contrary, in the absence of a major geopolitical scare we doubt that there will be anything more than a countertrend rebound over the next few weeks. This is because the risk-on trend is still very much intact in the stock market, the gold/oil ratio has begun to trend downward due to temporary strength in the oil market and a downward correction in the bond market has not yet run its course. What it means is that in the short-term there is not much additional scope for gold mining stocks to weaken relative gold.

By the way, we did not expect that the HUI/gold ratio would re-visit its 2022-2023 lows at this time. Our expectation was for a normal correction from the late-December high, which would have taken the HUI/gold ratio no lower than its 40-day MA (the blue line on the chart) before the short-term upward trend resumed.

Gold mining stocks also look cheap at the moment relative to general mining stocks. This is evidenced by the following chart, which shows that the GDX/XME ratio has almost dropped back to its lows of 2022 and 2023 even though gold has been trending upward relative to the Industrial Metals Index (GYX) since the first half of 2022. The comparison of the GDX/XME ratio and the gold/GYX ratio suggests that gold stocks have some catching up to do.

A cycle peak for the GDX/XME ratio is ‘due’ this year, so the catching-up should begin soon. We suspect that gold mining stocks will reach their next cycle peaks relative to general mining stocks in the same way that a character in an Ernest Hemmingway novel described how he went bankrupt: “Gradually and then suddenly.”

So, a reasonable argument can be made that gold mining stocks, as a group, are cheap right now. At least, on an intermediate-term basis they are cheap relative to gold bullion and general mining stocks. This provides no information about likely performance over the next few weeks but creates a good set-up for large gains to be made within the next six months.

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

The year-over-year growth rate of the US CPI was reported last Thursday to be 3.4%. This was 0.3% higher than the number reported for the preceding month and 0.2% higher than the average forecast, but the overall picture (refer to the chart below) is unchanged. The downward trend that began in June of 2022 is intact and we expect that the 2023 low will be breached during the first quarter of this year. However, the main purpose of this discussion is not to delve into the details of the latest CPI calculation but to debunk the persistent idea that the price inflation of 2020-2022 was mainly due to supply disruptions.

The idea that the price inflation of 2020-2022 was transitory and mainly due to supply disruptions is absurd, but many smart people continue to tout this wrongheaded notion. Based on the above chart a reasonable argument can be made that the rapid PACE of inflation (currency depreciation) was transitory, but not the inflation itself. Let’s consider what would have happened if disrupted supply actually had been the dominant driver the high “inflation” of the past few years.

The following chart shows the price of natural gas in Europe. This is an example of what happens when a supply disruption is the main cause of a large price rise. After the supply issue is resolved, the price falls back to near where it was prior to the disruption.

By the way, there are many commodities that over the past few years experienced spectacular price rises due to disrupted supply followed by equally spectacular price declines. We could, for instance, make the same point using a price chart of oil, wheat or coal.

The next chart shows the US Consumer Price Index (the index itself, as opposed to a rate of change). This chart makes the point that on an economy-wide basis, NONE of the currency depreciation of 2020-2022 has been relinquished. In fact, prices in general continue to rise, just at a slower pace.

It’s happening this way because the main driver of the inflation was a huge increase in the money supply combined with a huge increase in government deficit spending. In effect, all of the purchasing power loss that has occurred to date has been locked in and the best that people can expect from here is for their money to lose purchasing power at a reduced pace. In this respect the inflation is operating the same way as compound interest, except that instead of getting interest on interest people are experiencing cost-of-living increases on top of previous cost-of-living increases.

So, when someone tells you that supply disruptions were the main reason for the large general increase in prices, ask them why the general level of prices didn’t drop after the supply disruptions went away. And why are we now getting more price increases on top of the price increases of the past?

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

Over the past few hundred years there has been a relationship between the extent of global military conflict and secular trends in commodity prices, with secular upward trends in commodity prices coinciding with increases in both the frequency and amplitude of military conflict. We’ve covered this topic in the past, but not recently (the most recent discussion was in 2017). Due to what has happened over the past two years, this is a good time for a revisit.

In his book “War Cycles Peace Cycles”, Richard Kelly Hoskins discussed the aforementioned relationship and presented a chart similar to the one displayed below. The chart depicts the secular trends in commodity prices over the past 260 years. Hoskins explained that most of the important military conflicts occurred during the up phases on the chart, and therefore referred to the secular commodity-price uptrends as “war cycles”. The secular commodity-price downtrends were termed “peace cycles”.

A plausible explanation for why long-term advances in commodity prices are accompanied by a general increase in military conflict is that war leads to more monetary inflation, government spending and government intervention in the economy, as well as large-scale resource wastage and supply disruptions — the perfect recipe for higher commodity prices. In addition, when structures get destroyed by war, the commodities that are embedded in these structures are destroyed and eventually get replaced as part of a rebuilding process, causing a large temporary increase in commodity demand. There is also a feedback mechanism whereby military conflict and the associated monetary inflation bring about higher commodity prices, while higher commodity prices add to international tensions and increase the probability of military conflict.

A new “war cycle” began with the secular low for commodity prices in 1999 and has been marked, to date, by the 9/11 terrorist attacks, the Afghanistan and Iraq Wars, the nebulous “War on Terror”, the “Arab Spring” uprisings, the overthrow of Libya’s government, the rise of the Islamic State organisation, an initial increase in tensions between “the West” and Russia in 2008 related to the expansion of NATO (in particular, talk of adding Ukraine and Georgia to NATO) and culminating in the annexation of Crimea by Russia in 2014, a long and devastating war in Yemen involving Yemeni factions and Saudi Arabia, a war in Syria, China’s provocative expansion in the South China Sea, a further increase in tensions between the West and Russia leading to Russia’s invasion of Ukraine in 2022, the Israel-Hamas war that began in October-2023 and the recent Houthi attacks on ships in the Red Sea.

At this stage the current war cycle has lasted about 25 years, while the average length of a war cycle during the period covered by the above chart is 33 years. Therefore, the historical record indicates that if the current cycle is close to the average length then we can ‘look forward’ to another 8 years or so of rising commodity prices and increasing geopolitical conflict.

[This blog post is an excerpt from a commentary published at speculative-investor.com about one week ago]

The latest calculation of the Personal Consumption Expenditures (PCE) Index, an indicator of “inflation”, was reported on Friday morning (22nd December) in the US. The following chart shows that the latest number extended the downward trend in the index’s year-over-year (YOY) growth rate, which is now 2.6%. Moreover, the “core” version of the PCE Index, which apparently is the Fed’s favourite inflation gauge, has risen at an annualised rate of only 1.9% over the past six months. This essentially means that the Fed’s inflation target has been reached. What does this mean for the financial markets?

An implication of the on-going downward trends in popular indicators of inflation is that the Fed will slash its targeted interest rates next year. That’s a large part of the reason why the stock and bond markets have been celebrating over the past two months.

It’s important to understand, however, that the markets already have priced in a decline in the Fed Funds Rate (FFR) from 5.50% to 3.75% (the equivalent of seven 0.25% rate cuts). This means that for the rate-cut celebrations to continue, the financial world will have to find a reason to price in more than seven rate cuts for next year. Not only that, but for the rate-cut celebrations to continue in the stock market the financial world will have to find a reason to price in more than seven 2024 rate cuts while also finding a reason to price in sufficient economic strength to enable double-digit corporate earnings growth during 2024. That’s a tall order, to put it mildly.

Our view is that the Fed will end up cutting the FFR to around 2.0% by the end of next year, meaning that we are expecting about twice as much rate cutting as the markets currently have priced in. The thing is, our view is predicated on the US economy entering recession within the next few months, and Fed rate-cutting in response to emerging evidence of recession has never been bullish for the stock market. On the contrary, the largest stock market declines tend to occur while the Fed is cutting its targeted rates in reaction to signs of economic recession.

Fed rate cuts in response to emerging evidence of recession are, however, usually bullish for Treasury securities and gold. That’s why we expect the upward trends in the Treasury and gold markets to continue for many more months, with, of course, corrections along the way.