Over the last decade gold has been one of the best performing metals as fears of inflation and an out of control federal debt surfaced. We should give full disclosure that we were purchasing shares in mining companies as far back as the late 1990’s, and still hold equity positions in mining companies today. Over the last month, we have had clients, potential clients, media outlets and others asking us if we believe that the run in gold is over.
In just the last 2 months we have seen gold bullion prices correct by 15%, and the XAU index (an index used for measuring mining companies’ stock values) has slid 20%. Many talking heads are calling for the end of a near 10 year bull run in the metal, while others are saying that this is a minor setback on gold’s way to new record highs.
Most investors purchase gold as a hedge against inflation, the idea being that if inflation goes up, the value of gold should increase as well. While this is a very nice thought on paper, it does not always hold true. Gold fell from $825/oz in 1980 to below $300/oz in the late 1990’s, yet we had noticeable inflation in that 20 year span.
An issue that many investors fail to realize (or intentionally disregard) is that gold can operate just like any other consumer good; if there is a high demand for it, the price will increase, regardless of the economic environment.
Another anomaly within the gold market involves the relationship between bullion and XAU prices. Historically, the bullion/XAU ratio ranges from 3-5. Today it is ranging from 13-15 as mining share prices have taken a much more substantial relative to bullion prices. We have not seen the ratio at these levels since the 2008 market correction.
While the selloff in bullion could be as simple as investors taking profits off the table, share prices of mining companies have seen a different story. Barrick Gold Corporation and Newmont Mining Corporation are of the largest precious metals mining companies in the world. Unfortunately for investors, both have taken on new projects which have yielded lower output than expected, all while substantially increasing their debt burdens. Barrick has since noted that they will eliminate 30% of their staff at their headquarters; however the effects have already been felt on their share prices.
A major factor that will affect the future of gold is the impact that QE funds will have on inflation. We have written before about the difference between “bank money,” or money that is freely flowing through to consumers through the banking system, and “state money,” or “monetary base.” Once QE funds begin to freely flow through the banking system, we could very well see inflation, but it is difficult to know for sure if or when exactly that will happen.
The argument for gold is one that has been around for decades; some investors buy into it, some do not. We caution all investors about becoming married to any investment, but in the case of bullion, becoming “gold bugs.” Creating an emotional tie to any investment can make it difficult to sell at the right time, or difficult to purchase when upside potential exists. We recommend that all readers take a step back and look at where gold has been, what could make it go higher, and decide if the economic fundamentals exist, or if the golden bull has begun to mutate into a bear.