Investment Strategy: Highlights Precious Metals
- Long term macroeconomic trends, as well as supply-demand factors are highly favorable to precious metals for the foreseeable future.
- Gold stocks offer greater leverage on a bull market in gold than bullion.
Supply / Demand Forces
On the demand side, China and India remain - to a large degree - the world’s largest buyers of gold. This demand for gold is endemic to the culture and will always be present. As these economies grow and the middle class attains more wealth, the demand for gold and investment alternates such as platinum will remain robust. It is often the case that when gold prices spike, purchasing of gold is delayed and potential purchasers will buy silver or platinum instead. Thus, a strategy of investing in the whole precious metals complex, rather than exclusively gold, makes sense as it provides greater opportunity and stability to the investment portfolio.
On the supply side, it is well-known that gold production has flattened in recent years with no significant additions to supply coming on the market in the next decade. The reasons for this are as follows:
During the last bull run in gold (2008-2011) many gold producers had begun expanding, taking on significant debt as they initiated new projects. During the subsequent decline in gold prices (2012-2015) these companies found themselves over-leveraged and had to divest or discontinue exploration and development. As a consequence, with few development projects initiated between 2012 and 2017, the world found itself in a position where there was simply not enough gold mines in development to meet prospective future demand. This is because taking a mine from discovery to production typically takes more than a decade to accomplish. Thus, we can project a significant disequilibrium between the demand and supply in the current decade.
As a result, capital is beginning to find its way into the financing of gold exploration and development projects. Large and intermediate producers are looking to expand and are embarking on new exploration projects as well as the acquisition of junior exploration companies, particularly those with large with large reserves. In brief, the industry is ‘hot’ again. Yet when compared to their previous peak in 2011, gold stocks remain comparatively undervalued from a long term perspective. As a result, we can expect this bull trend in gold stocks to continue for many years to come, particularly when we consider macroeconomic variables. From a microeconomic perspective, with capital at historically cheap levels, as well as a cheaper input costs (primarily diesel fuel), the cost of exploration and development of new gold projects has decreased, thereby making gold producers more profitable.
The macroeconomics of the gold market are equally, if not even more compelling.
- Yields on government bonds have collapsed as Central Banks around the world continue to print money in the hopes of spurring growth and exports. This has led to a devaluation of global currencies and a case of foreign investors being forced to place investment capital in the ‘least worst of all’.
- Real economic growth has not returned to the global economy. Instead, we have experienced global stagnation. As a result, companies have engaged in buying back their equity (financed by cheap debt) rather than reinvesting in their enterprises. With limited prospects for growth investors are beginning to shy away from inflated equity markets. This capital needs to find a home.
- Astute investors recognize that we have entered an era of global stagnation, similar to what Japan has been experiencing since 1990. As a result, investors are far more interested in preservation of capital than they are in chasing beta in an increasingly unstable, yet stagnant global economy. Investment in government treasuries bears its own risk since nations continue to devalue their currencies through dovish monetary policy. In fact, since devaluation of a nation’s currency is a means of paying off debt, there is significant incentive for countries to continue their current trend of currency devaluation. Precious metals remain the most well-regarded hedge against currency devaluation.
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