This transcript is based on a panel discussion held in February 2022 as part of our Assay Live series. It features Jordan Eliseo, The Perth Mint; Wayne Gordon, UBS; and Warwick Grigor, Far East Capital.
2021 saw gold prices settling from their 2020 highs, and investment was relatively understated. Some analysts are now predicting that gold could rise significantly again in the coming year. In terms of the outlook for gold in 2020, where do you think we are going to go in terms of supply, demand, and pricing?
Jordan Eliseo: My view is that gold is relatively well placed this year and that the correction we saw for most of 2021 was pretty healthy. The gold market had a huge run between roughly Q3 of 2018 and September of 2020. In US dollar terms, gold was up about 70% peak to trough in that period. What we’ve seen over the last 15 months is gold working off some of the excess froth that had built up in that time, so it’s now trading at around US$1800.
Much of the bad news regarding gold, most notably interest rate hikes expected by the federal reserve and other central banks, are priced in. The market has had time to recalibrate pricing, not just for gold, but for a range of asset classes. So, one of the really encouraging things last year was that gold consumer demand was reasonable.
Warwick Grigor: There’s a geopolitical uncertainty offered by China and Russia, there have been reports that those countries have been soaking up gold every time it starts to come below that US$1800 price.
As with negative real interest rates, gold is always going to do well. With inflation running at 5%, 6%, or 7% in the US, for example, interest rates are a long way down so, the interest rate argument as to why gold prices should go down isn’t working now, because interest rates are still negative.
Bitcoin and more aggressive speculative assets are said to have sucked money away from gold, but that’s at the margin. The real gold holders that provide the depth of strength in the market are long-term holders that keep putting it away. We shouldn’t get confused by flippant short-term trading activity.
Wayne Gordon: Most investors holding on to gold are doing so because inflation continues to surprise to the upside.
If you look at 10-year real interest rates in the US, they have moved about 60 basis points higher than where they were in the fourth quarter of last year. Usually when that happens, gold comes under material pressure. That has really disrupted a lot of these elevated valuations in a lot of the favored stocks coming out of the pandemic, like the tech stocks.
Once the market has settled around some number about quantitative tightening from the fed, then the reasons for holding gold are likely to come under more scrutiny. We predict gold will fall back to the US$1650 mark by the end of ‘22.
Gold has always held this position as a safe haven investment. Do you think that it will continue in this state?
Wayne Gordon: People ask if Bitcoin is the new digital gold. I think this event that we’ve seen recently where Bitcoin is halved or more than halved in a very short period, really amplifies the view that these things are different assets. You shouldn’t consider them as like and like.
Bitcoin doesn’t materially add to the diversification of a portfolio. Returns are good when Bitcoin is rising, and it does provide additional total return to a portfolio, but you need that digital network to support those digital assets, as Bitcoin is not fungible across all platforms, unlike gold.
Bitcoin and other digital assets might become more fungible, and they might get used more in day-to-day trade. I’m not suggesting that gold can be used in the day-to-day exchange of goods. However, gold is the ultimate insurance asset in this context, alongside of many other things such as US treasuries for example, but we still think that gold holds that place.
Jordan Eliseo: Bitcoin is great if you want a speculative asset and you’re happy to take the risk of losing a substantial amount of your capital in the hope of making profit, but it clearly isn’t the safe haven that gold is. It hasn’t exhibited a negative correlation to equities when they fall. It hasn’t exhibited strong price growth in sustained high inflation environments over the long run.
If you take the most speculative company listed on a stock exchange, it only needs a tiny amount of money to go into it for its price to double or triple. That’s a very different investment proposition to a blue chip with a trillion-dollar market capitalization, for example. A lot of people will look at Bitcoin and go, “Wow, this thing’s gone up 200% annualized for 10 years.” But that’s because when it started, it had a market cap of zero. For Bitcoin to double now, it will need to increase in market value by almost another US$1T.
Warwick Grigor: Bitcoin’s vulnerable to a new toy coming along next week, but gold’s not. Gold has survived the test of time.
Jordan Eliseo: If the market is telling us anything, it’s that as cryptos evolve and will likely become part of the financial system going forward, monetary use of crypto is becoming less important and less significant as a segment of the overall crypto market share.
Why do you think this conversation has come up directly correlating gold versus Bitcoin?
Jordan Eliseo: Bitcoin’s really been around for the better part of ten years. That ten-year period has been pretty underwhelming for gold as a whole. Gold hit the better part of US$1900, announced for the first time in 2011. Ten years later, we’re still here. Gold has basically treaded water, whilst this shiny new toy has been delivered to the market, is being advertised as a competitor, and has had this phenomenal price growth off of a standing start.
With its extreme volatility, how can Bitcoin be viewed as a stable store or value, or I suppose can it be seen as a stable store of that?
Wayne Gordon: Bitcoin has an emerging scarcity value. Gold has a scarcity value in the context of limited amounts being available on Earth, and Bitcoin is viewed in a similar way. People think Bitcoin could be a diversification asset and maybe it does perform better during periods of high inflation relative to gold, because gold’s performance during periods of inflation or inflationary periods has been mixed.
This leads into an interesting discussion about the ESG factors relating to investment and holding these commodities, gold versus bitcoin and the green aspects of mining gold and mining bitcoin.
Jordan Eliseo: Gold is a 100% recyclable asset, it ticks the box from an ESG perspective. With Bitcoin, it’s certainly far more of a question mark. I think the estimates are now that if Bitcoin was a standalone country, it would rank as number 39 for overall electricity usage which is extraordinary. Ultimately, the view of Bitcoin would be that it is a hard currency, which is the key to a more sustainable and fairer financial system, so some would say the carbon emissions are worth it.
As a speculative vehicle, Bitcoin is probably the most energy intensive form of gambling ever created. My gut feeling for institutional investors is that ESG is going to be a big barrier for them to allocate capital to bitcoin, because they are not buying bitcoin to use in the local coffee shop. They’re buying
Bitcoin purely as an investment asset, and the ESG factor is going to be one of the screens that it needs to get run through. Right now, I think bitcoin fails.
Wayne Gordon: We offer our clients what’s called “green gold”, where there is a premium to that for a whole bunch of reasons such as certification. However, most mining companies are doing an extraordinary level of work to make their processes, their governance, and the way in which they interact with local communities to improve their overall processes and supply chains.
Inquiry from the client side has risen materially as well. We basically had to push and pull through the system. I’m very positive about the industry’s ability to cut emissions, improve its performance, and improve governance overall.
Jordan Eliseo: There’s a link there between the ESG factors, which I think favour gold over Bitcoin at this point and more broadly governance and regulation around the two industries. Gold is an incredibly deep liquid market. That gives investors confidence that the asset trades in a market in which they can feel comfortable with.
Gold is an incredibly deep liquid market. That gives investors confidence that the asset trades in a market in which they can feel comfortable with
There are huge question marks around the actual liquidity in some Bitcoin markets. If you look at the United States, the SEC is still yet to allow the listing of a spot-based Bitcoin ETF. I think ESG can be wrapped up with broad economic governance and regulation concerns that institutional investors will have.
Warwick Grigor: One of the theoretical and practical arguments as to why gold is good in times of inflation, is you can’t debase gold due to the limited supply. Almost every ounce of gold that’s ever been mined is still on the surface and can be recycled, but incremental gold production each year is somewhere in the range of a 1% to 3% increase. If inflation is linked to the rate of increase of money supply, being in one, two, or three or whatever, you can get all money supply increasing by 10% or 20% in inflationary times.
That erodes the value of that currency significantly. The reason why you hold gold is because you’re not going to debase that store of gold by more than 1% or 3% per annum, which is always going to be less than 5%, 10% or 15% inflation.
Do you think the gold mining industry will embrace full value chain tracking, like the diamond industry has?
Jordan Eliseo: I can speak a little bit about what the Mint has done in the sense that there’s been two or three major initiatives over the last couple of years around governance and of the supply chain. As for whether it’s ever going to replicate what the diamond industry has done, I don’t think the gold industry is in a position to do that.
What about specific companies and their outlook? You can bring in the ESG concerns, but also everything else that you use to assess companies and potential investments.
Warwick Grigor: In my 40-year history as a gold analyst, I have looked at investments in gold companies more for their growth and earnings potential. Once you’re an established a mature producer, you’ve got different considerations, and that’s where corporate activity comes into it.
Whenever I’m talking to clients about buying into gold, I’ll always be looking at a company’s gold expansion. You need to look whether they want the stability of the gold price and the liquidity of very large highly traded stocks like Newcrest or Evolution, or whether they want to factor in growth through expansion, which brings in a whole lot of different set of risks.
First time gold producers make mistakes. It is a riskier time to buy shares in a gold company as it starts to finance and develop a project a year after it’s been operating. People who want real leverage and a bit of speculative fun, can go to the exploration end, and there’s nothing like gold that when you discover it, it’s like discovering money in the ground. Whenever I’m talking to investors on gold, I’ve really got to find out what their risk tolerances and preferences are.
I have noticed over the last six to 12 months that gold stocks in Canada, the medium size developers and explorers, are half of the price or even less than that in terms of or greater discount than what the Australian stocks are. There’s probably no jurisdiction in the world which is as good at providing joy for investors as Western Australia.
Wayne Gordon: When we look at the gold sector, the first thing that we think about is the price dynamics. The gold sector is highly correlated to the movements in the gold price. As an investor in gold stocks, whether it be at the index level, or the individual company level, you must remember this and that’s key at the moment. When you look across the board at mining materials, gold stocks probably offer some of the best value from a mining materials perspective within that portfolio.
Gold producers often have other materials, such as copper and lithium. You also need to think about how the suite of metals in which they’re producing are contributing overall to the company’s revenue streams. As I look across all the big gold names, I’m not positive right now, just because I have a negative view on the gold price.
It’s not to say that in 18 months’ time, we won’t have a situation where we become a bit more neutral on gold, and then some of these companies will offer enormous value to the upside. But when we think about the cost of probably the 80% cost of production, it’s probably around the US$1200, US$1300 an oz, which would be the upper end across the spectrum.
Strategically from a mining materials perspective, probably some of the best value in the mining materials sector sits in the gold sector currently as we speak.
Warwick Grigor: The supply and demand analysis for gold doesn’t work in the same way as it does for other metals. What gold you can produce, you can sell, and the market is very deep. There’s not one project which is going to move the market. Whereas a lot of these specialty metals, you can find there might be 10 or 20 mines in the world, and a new project can shift the curves, but gold is much deeper than that. There’s also much less like little disruptions to the gold price from operations, new or expanding.
It might be interesting to hear our panelists thoughts on what we can expect in the next 12 months.
Wayne Gordon: We see real rates continuing to move higher in the US, and we think that inevitably valuations and equity markets will somehow come about to some sort of equilibrium with all these changes in expectations for the costs of capital.
When inflation peaks, it’s a key trigger point for gold coming under more evident pressure, where earnings and valuations end up on other assets and when we think the fed is fully priced. Because the way yield curves are behaving, it feels like we’re mid moving into late cycle in the economic cycle. COVID disrupted one of the longest cycles we’ve had in recent memory. While it might feel a bit painful in gold for the next 12 to 18 months, the prospects of the very short hiking cycles of central banks may bring gold back in favour more quickly as well.
I think investors need to be mindful of that in the short term but be more strategically positive for gold as we look forward over a 5-year basis.
Jordan Eliseo: Seeing gold drop down to the US$1650 or US$1700 range wouldn’t surprise me. In terms of percentage US dollar terms, it’s only about an 8% pull back from where we are now. In Australia, the environment where gold moves to US$1650 is probably only if the Aussie dollar falls back below 70. The decline for local investors would be even less than 8%. Long term allocators are starting to get encouraged with what they’re seeing with gold now.
One of the things that has been fascinating this last year is that if you look at five and ten-year break-even rates, they never really got anywhere much past two and a half, 2.75%. Right now, they’re back down to about 2.4%. The market is already expecting inflation to dissipate and fall away going forward.
Warwick Grigor: There will be a rush to get more gold. The markets have tried to crunch down, and you’ve got to appreciate that the traders make money out of volatility. They’ll test on the short side and on the upside to see how much they can move the markets once they’ve got set. They’ll do a campaign. You might call that manipulating of markets and it is to some extent.