As of December 30th, 2022, gold bullion closed at US$ 1,824.02/oz., an increase of 9.8% in USD respectively 0.4% in EUR in Q4, 2022. For the year 2022 (Dec. 30th, 2021 to Dec. 30th, 2022), gold was virtually flat in USD (+0.5%), while rising 6.2% in EUR. The Philadelphia Stock Exchange Gold and Silver Index increased by 19.8% (USD) / 9.5% (EUR) during Q4, 2022 and ended the year with -8.2% (USD) / -3.0% (EUR). Nestor Gold Fund (-B- share class) gained 27.3% (USD) / 16.3% (EUR) in Q4, 2022 and ended the year 2022 at -6.0% (USD) / -0.7% (EUR). The fund outperformed in Q4 and in 2022 despite the fact that explorer/developer lagged substantially during 2022.
The gold price recovered in Q4, 2022. Physical gold demand has continued to be strong. ETF selling continued, but at a much more reduced pace than during Q2 and Q3, 2022. Gold miners reported their Q3, 2022 results, which were mostly in line with expectations. While higher costs (oil, reagents and other consumables, mostly oil derivatives) continued to be key themes, costs pressures have started to abate thanks to oil price weakness, lower steel prices and signs of less labour market tightness in certain markets. The gold companies continue to be very disciplined, a key differential factor from the previous cycle.
Game changer in the physical gold market? Gold rises despite further ETF selling!
We were wondering, in spring 2022, if central banks of “non-NATO countries”, or “not America’s best friend countries” would react after the freezing of Russian foreign exchange reserves. An unprecedented action rang the alarm bells in these countries, as accumulated reserves for difficult times from one day to the next can no longer be accessed, depending on the political view of America as well as the Western countries. The USD, Euro and western foreign currencies suddenly turn out to be a risky asset and no longer perform their intended purpose.
Surprisingly, it didn’t take a long time before central banks around the world began converting some of their immense currency reserves into gold in Q3. Given the very low percentage of gold in central bank balance sheets, this new trend will likely continue for several years, or at least until the rising tensions between the West and the East abate significantly; something that looks extremely unlikely during the next few years.
Gold becomes in fact the only currency independent of political will and the only safe asset in the balance sheet of central banks!
This so far turns out to be a game changer in the physical gold market and explains the fact that gold has been rising in Q4, 2022 despite further ETF selling, something very untypical in the last 10-15 years.
To summarize, unlike the last 10 years, when ETF purchases were necessary for the price of gold to rise, this isn’t the case anymore given the changed behaviour of central banks. Now, and likely in the next few years, it doesn’t take a lot to create a deficit in the physical gold market, as can be seen in the chart above, even under the assumptions of less aggressive central bank buying and less bar and coin demand than in Q3, 2022.
Given that most tactical oriented investors sold their gold ETFs (from April to early December 2022) due to fears about the FED hiking cycle (soon to end), the strong US dollar (likely ended) and due to unrealistic expectations of sharply rising real rates (starting to reverse), the pressure from ETF holders has abated during the last few weeks, as can be seen in the chartt:
Total ETF gold holdings
Economic deterioration and declining inflation leading to the FED pivot during H1, 2023
There is no end in sight for the economic slowdown based on our leading indicators, which turned very negative in late 2021, well ahead of consensus. The slowdown exhibited during 2022 will eventually turn into a recession during the next few quarters. Inflation pressure has peaked and will fall more sharply in early 2023. There are also more and more signs that labour markets and wage pressure have peaked too.
While gold and gold miners have started to benefit in Q4, 2022 from the soon to be expected FED pivot, they will likely increase much more during the next few quarters, as they did in 2019/2020, following the FED pivot in early 2019 as well as the less hawkish messaging in late 2015/early 2016.
In the past, gold and gold miners reacted months ahead of the change of monetary policy (pivot), bottomed earlier than equity markets and were the winners in initial phases of ascending markets (2001-2003, as of Nov. 2008, as of January 2016, as of 2019/2020), when gold equities performed significantly better than other asset classes. Therefore, we consider the end of September to have been the major turning point in gold miners, similar to early 2016 and late 2018, when interest in gold and gold miners, positioning and sentiment were comparable to late Q3, 2022.
But what if the FED doesn’t pivot?
Due to structural changes in the labour market, as well as potentially renewed increases in commodity markets during 2022, there remains a risk that the FED won’t pivot and the economic environment stays more in a stagflation-like scenario, something not at all priced in today by the financial markets. This would likely lead to a replay of Q1, 2022, when gold, gold miners and other miners were rising, while the general equity market, the real estate market and the bond markets suffered heavy losses.
However, unlike 2022 the market is likely to start understanding the structural inflation changes, as below, while the FED can’t increase interest rates further (different from 2022) due to the recessionary environment and rising unemployment.
The major and so far badly acknowledged structural forces have recently changed dramatically, i.e.
• labour market to remain tight due to demographics (much more retirees relative to new entrants). This will lead to a change in power from the employer to the employees
• global saving pattern has started to switch to a major dissaving trend (similar to 1950-1980 and different from 1980-2015), historically a major driver of inflationary trends
• end of globalization, which was very disinflationary and led to record high profit margins due to outsourcing to China, etc. The need and willingness to become more and more independent from China and countries not liked in the Western world is highly inflationary
• new commodity super-cycle has started in early 2020, after 10+ years of massive under-investments (partly because of ESG reasons), i.e. instead of disinflationary trends between 2008-2020, commodities will be inflationary
In addition to the four major trends (as above), which are structurally changing from disinflationary to inflationary, we also see decarbonisation as an additional element of rising inflation. Greenhouse gas reduction needs a lot of costly infrastructure investment and therefore a great deal of resources.
The fact is that gold miners, gold, miners and commodities have proved by far to be the best asset classes in a stagflation-like environment. Therefore, if the FED doesn’t pivot during 2023 this would be highly positive for gold miners (best asset class in stagflation) and investors would need to look back into the 1970s to have some reasonable guide for 2023 and the next years.
2023 should just be the start, as the new macro super cycle kicks in
Thanks to very low and stable inflation, financial markets were driven during the last 10 years by the zero interest rate policy (ZIRP) and irresponsible monetary policies, leading to a massive speculative wave. Thanks to extremely low discount rates and very cheap funding, investors focussed on highly speculative investments like (loss-making) high-growth equities and long-duration equities. Gold and metal miners were underperforming sharply, similar to the 1990s and to the roaring 1920s.
This period, which led to an “everything bubble” (expect gold and commodities) has ended with the pandemic, the structural inflation changes (as above) and the more and more challenging geopolitical situation between the Western and the Eastern world (China, Russia, etc.). Higher and more volatile inflation, no more ZIRP and less accommodative central banks will be the “new normal”. However, real interest rates need to stay negative, to avoid an even bigger acceleration of debt/GDP-ratio.
This will likely lead to a structural outperformance period of value/commodity/short duration equities, similar to 2000-2008. As commodity prices have bottomed after 10+ years of under-investments, gold and metals miners will structurally have better earnings growth (thanks to higher metal prices) than the general equity market. Unlike growth stocks (long duration assets, which suffer from higher interest rates/inflation), they will be precious within the equity market and will likely rerate from today’s very depressed valuations.
While the last 10 years have been very challenging for gold mining investors, and patience has been tested over and over, the new macro super cycle points to a much better future.
As a result, we forecast that the 2020-2030 period will be similar to the one from 2000-2008/11 for gold miners (structural bull market), while the big beneficiaries of the 2010-2020 environment (high growth stocks, cryptos, real estate and broad equity markets) will likely have a more challenging period, similar to 2000-2008, when they consolidated their gains of the 1990s!
There is a major game changer happening in the gold market due to the freezing of the Russian foreign exchange reserves. As a result of that, unlike the last 10 – 15 years, when ETF purchases were necessary for the price of gold to rise, this isn’t the case any more given the changed behaviour of central banks. Now, and likely in the next few years, it doesn’t take a lot to create a deficit in the physical gold market, even assuming less aggressive central bank buying and less bar and coin demand than in Q3, 2022.
There is no end in sight for the economic slowdown based on our leading indicators and it will eventually turn into a recession during the next few quarters. Inflation pressure has peaked and will fall more sharply in early 2023 leading to a FED pivot, which has historically (2016, 2019/2020) been extremely bullish for the Nestor Gold Fund.
Even if the FED doesn’t pivot as expected, due to higher inflation than discounted by the markets and the FED, gold miners, gold, miners and commodities will likely prove to be by far the best asset classes (stagflation-like environment). Investors would need to look back into the 1970s – when gold miners proved to be the best asset class - to have some reasonable guide for 2023 and the next years.
We consider the end of September/early November lows to have been the major turning point in gold miners, similar to early 2016 and late 2018, when interest in gold and gold miners, positioning and sentiment were comparable to late Q3, 2022.
The Nestor Gold Fund is perfectly positioned for such an outcome. The well-above-average exposure to medium/smaller producers and exploration and development companies is a key differentiating factor of the Nestor Gold Fund relative to active and passive peer products and should lead to substantial outperformance as it has done in the past.
While the last 10 years have been very challenging for gold mining investors, and patience has been tested over and over, 2023 will likely be just the start of a multi-year outperformance period, as the new macro super cycle points to a much better future.
Accordingly, the promising strategy for investors in the gold mining sector in the next few years should therefore be "buy the dip" instead of "sell the rally".
Walter Wehrli and Erich Meier, Konwave AG