After a weak start to the year, the gold price is up 8 percent year to date, continuing to hold its own despite the strength in the stock market.
Unfortunately, gold stocks haven’t kept up with the yellow metal this year. In fact, they’ve underperformed it, a of last year. But gold stocks usually underperform gold: During the past twenty years, gold stocks fell behind gold 70 percent of the time.
The main reason is that few gold companies are able to successfully navigate the rising cost of mining.
In the past 10 to 15 years, gold production has been stable while growth has been elusive, no matter the increase in capital spending.
Currently, capital expenses are lower, although they’ll have to climb again to protect against declining production. This is in large part because companies find it increasingly difficult to replace reserves, and so they turn to more expensive project.
Furthermore, according to company data, gold producers found ways to cut their (all in) costs from around $1,700 per ounce in 2012 to $1,100 per ounce in 2016. Although this reduction helped companies deal with the drop in the price of gold, it’s not sustainable. Those costs started to rise again this year.
Things aren’t becoming easier for gold companies either. Around forty percent of the world’s gold reserves are in places where regulatory uncertainty is the norm. And exploration companies are being asked to pay ever-increasing fees (royalties, taxes, labor costs, electricity, etc.) for access to these reserves. A lot of times, too, new reserves are of lower quality.
These are long-term headwinds that gold companies have to go against. Coming out on top will be difficult and achieved only by a few.
Long-term readers may remember that we view gold as a currency and not a commodity. As J. Pierpont Morgan once said while answering questions from Congress about a financial crisis: “Gold is money.”
Gold can’t be consumed, as are other commodities like oil or iron ore. On the contrary, it can be held for a long time and in numerous forms. It’s proved its value as a safe-haven asset. Therefore, our view is that it’s the only true long-term hedge for a long-only portfolio.
With the market running hot since 2009, investors should start adding gold to their portfolios in case the bull market stops for a breather, or worse. Keep in mind that gold gains in value during times of geopolitical uncertainty, when investors worry about monetary issues or when the stock market experiences a sharp selloff.
For example, in the bear market of 1973-74, gold gained 143 percent while the S&P 500 lost 41 percent.
During the next four big sell offs–occurring between Sept. 1976 and Oct. 1990–gold also outperformed the S&P 500. During those periods, the S&P 500 fell an average of 19 percent and gold gained nine percent.
In addition to the possibility of a market correction, the geopolitical picture remains murky. This is especially true so long the North Korea issue isn’t addressed in a pragmatic way. A military confrontation with North Korea will send stocks down fast and gold prices up faster.
These kinds of uncertainties should remain in the forefront for some time. As a result, the price of gold should stay stable if not trend a little higher.
Demand from investors for exchange-traded funds (ETFs) will also play a role in the potential next leg up for gold.. Although global gold ETF holdings have been growing, they’re still lower than previous highs. And yet, gold has held up this year.
In addition, the yellow metal remains the best way to profit from growing concerns about the efficacy and long-term consequences of central banks’ extraordinarily accommodative monetary policies. These fears always come into the forefront when “normalization” is under way and investors try to hedge against potential policy errors.