Gold stocks look great right now. They are winning on multiple fronts. And gold itself is capturing bullish headlines via central buying at the highest levels in 50 years. It’s a very attractive setup for gold stocks heading into 2019.
So, what makes gold stocks look great?
- They are showing strong signs of turning a corner and trending higher.
- Their valuations are cheap on a historical basis.
- There are multiple scenarios where gold and gold stocks can keep winning.
- The Federal Reserve, in its recent switch from hawkish to dovish, is putting a tailwind behind gold’s back.
And as we mentioned, central bank gold-buying hit the highest levels in half a century last year — all the way back to when President Richard Nixon took America off the gold standard in 1971!
It’s hard to beat that combination. Gold stocks could be a big winner for investors in 2019.
In December 2018, we said gold and gold stocks were climbing a wall of global slowdown worry. That climb continues. At the time of the December editorial, spot gold was below $1,270 per ounce; as of this writing in February 2019, the spot gold price had recently touched $1,330 (nearly 5% higher).
The December editorial also showed nine gold stock components from GDX, the bellwether gold stocks ETF, that were trading in the SSI green zone. As of February 2019, instead of nine components there are 12 (as you can see below). Things are moving in the right direction.
So, what is going on? As we said in December, there are growing fears of global economic slowdown, especially outside the United States.
There is an increasing consensus that China’s unprecedented 40-year growth boom could be coming to an end. Europe is looking shaky, with its powerhouse, Germany, flirting with recession. And global debt levels are alarmingly high.
All of this favors gold and gold stocks, as governments usually respond to slowdowns by ramping up spending and debasing their currencies (enacting policies akin to “printing money”).
Meanwhile the U.S. economy looks strong — the U.S. saw its 100th-straight month of increased employment in January, and hiring was robust in spite of the 35-day government shutdown. But U.S. stock market investors are recovering from a double bout of whiplash.
The first bout of investor whiplash comes from back-to-back extremes of market performance. Here is what that means:
- The market closed out 2018 with its worst December performance since 1931 (the early years of the Great Depression).
- But January 2019 was then the best month for U.S. equities in more than three decades, with the S&P seeing its biggest rise since 1987!
Talk about “the best of times and the worst of times” (or maybe reverse that). What can lead to the worst month for stocks in almost nine decades, followed by the best month in over three decades?
Some believe it was the changing stance of that other whiplash source, the Federal Reserve.
The current Chairman of the Federal Reserve, Jay Powell, had previously appeared to be an “inflation hawk” — someone who worries about inflation and is inclined to hike interest rates at the first sign of it.
When the Federal Reserve pushed through a rate hike in December — instead of going for a “pause” as many thought they should do — the mood of investors shifted from worry to mini-panic.
But then Powell and the Federal Reserve changed their tune dramatically — as if to say “OK, we got the message!” — which made the markets happy again and fueled a giant rebound.
Higher interest rates are seen as ending the party for stocks. But if the Federal Reserve sits back and keeps interest rates low, the party can go on a bit longer.
So, the Federal Reserve sending signals that they “got the message” may account for the sharp vertical rebound for stocks in January.
This dovish turn for the Federal Reserve is also very good news for gold stocks, because if interest rates stay low a while longer, there is a greater risk of inflation coming back — and when investors fret over inflation they tend to buy gold, which juices the profit outlook for gold miners.
At the same time, there is another way gold and gold stocks can win, even if inflation never materializes.
If the whole world goes into an economic slump, and the United States economy gets pulled down along with it, you can bet that central banks and politicians will sound the alarm and start enacting new stimulus measures.
If this happens, the value of paper currencies will get debased as worries over global debt levels fill the headlines — and gold and gold stocks will go up even faster.
And it’s not just the Federal Reserve that is a friend to gold now (with its pivot to dovishness and the signal of keeping interest rates low).
It’s central banks everywhere, as central bank gold buying reaches its highest point in 50 years!
Because of trade war concerns and geopolitical turmoil, central bankers the world over are starting to worry about their exposure to the U.S. dollar. They are taking action on those worries by stepping up their gold purchases (swapping out dollars and U.S. treasuries for gold). As the Financial Times reports:
“Central bank buying of gold reached its highest levels for almost half a century last year as Russia, Turkey and Kazakhstan boosted purchases to shift their reserves away from the U.S. dollar.”
There were plenty of other central banks making the same move — Russia, Turkey and Kazakhstan were just three of the standouts. Russia’s gold purchases represented a 74% increase from the prior year. China, which already had substantial gold reserves, has started buying again for the first time in years. Hungary increased its gold reserves tenfold, to the highest levels in more than 30 years. And so on.
This further shows how the current environment is positive for gold because, in addition to acting as a hedge against inflation, and a secondary hedge against paper currency debasement, gold is also a hedge against trade war turmoil and destabilizing geopolitical events.
- If stocks creep higher as the Federal Reserve stays dovish, the U.S. economy heats up, and interest rates are kept in check — gold could do well as a result of rising inflation fears.
- If the world goes into full-blown economic slowdown and the U.S. follows — gold could benefit as a hedge against paper currency debasement.
- And central banks are buying gold at the fastest clip in 50 years as a hedge against trade war fallout and geopolitical concerns, with those buying drivers likely to persist.
Meanwhile, we emphasize the return potential of gold stocks over gold itself because, if spot gold sees a sustainable rise in price, that leads to a rapidly expanding multiple for gold miner profits.
For example: If a miner has all-in costs of $1,000 per ounce, and the price of gold goes from, say, $1,200 to $1,400, that is less than a 17% increase in the price of gold itself.
But all other things being equal, it represents a doubling of profits for the miner (from $200 per ounce in profit to $400 per ounce).
And if gold sees a powerful and sustained rise in price — say on the order of 50% to 100% or more — gold miner profits could explode through the roof. When profits are rising at the same time an industry sees multiple expansion (the earnings multiple going up at the same time as the earnings), that is when huge investment gains are made.
In conclusion: With multiple ways to win, a big rounding bottom in gold, an increasingly positive trend of gold stock names with green SSI status, a big tailwind from central banks, and the built-in possibility of explosive upside, it’s hard not to like gold stocks this year!
Richard Smith, PhD
CEO & Founder, TradeSmith