The gold market consolidated in Q3, 2022 due to outflows from gold ETFs and further selling pressure at COMEX. Gold miners reported their Q2, 2022 results, which were mostly in line with expectations. Higher costs (oil, reagents and other consumables, mostly oil derivatives) were the key themes. Fears about further cost escalation seem exaggerated to us, as many companies confirmed, during meetings over the last few weeks, that cost pressures are abating somewhat. In addition to the retreating oil and steel prices, the strong USD and likely higher productivity during H2, 2022 (seasonality) should keep the cost pressure under control, especially since companies continue to be very disciplined, a key differential factor from the previous cycle.
Why did gold and gold equities not live up to expectations?
While we are going through a stagflation during 2022, which should lead to significant gains in the gold price and even more so in gold miners, the reality is that 2022 has so far proved to be a very difficult environment for precious metals investments. We consider the following as the major headwinds in 2022 for gold:
• sharply rising real rates (based on 10 year TIPS)
• rising US long-term yields
• significant USD strength
• rising Fed fund rates (sharpest rise ever over a seven-month period)
Gold miners suffered from the declining gold price during the last six months, from selling in gold mining ETFs and from cost increases mainly driven by oil prices, reagents and other oil derivatives (consumables) and raising steel prices as well as lower production (seasonality) and Covid-related absentees.
The good news is that all of these developments don’t seem sustainable (further rise in real rates is highly unlikely, rising long-term yields given our economic and inflation outlook, USD strength unlikely to continue as we approach the end of FED tightening, oil and steel prices have already started to decrease sharply).
Why will the FED pivot earlier than discounted by the markets?
The FED has historically unfortunately proved that they have no real insights into the economy, always acting too late (many policy mistakes in the last 20 years), but also reversing to easier monetary policy quickly when economic and unemployment fears rose and when market stability was at risk.
Important is that the FED (and the markets) underestimate the economic weakness. There is no end in sight for the economic slowdown based on our leading indicators, which turned very negative in late 2021 already, well ahead of consensus. While gold and gold miners haven’t benefited yet from the soon to be expected FED pivot, they will likely do so in 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.
The “technical recession” will turn into a deeper recession during the next few quarters (real estate market to weaken further). Inflation pressure has peaked and, based on our leading indicator models, will start to fall sharply in early 2023. There are also clear signs that labour markets and wage pressure have peaked too. Further weakness in equity and real estate markets might lead to an even quicker FED pivot than our Q1, 2023 expectation.
In the past, gold and goldminers 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 should be close to a 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 today!
Why stagflation will be the new normal
Demographic trends (positive in the 1960s to 1990s, now boomers starting to retire), the excessive indebtedness of governments and the private sector (at an all-time high) and the consumer saturation in industrialized countries all point to lower and lower growth, a trend we have seen since the 1950s! This structural trend has significantly worsened further due to the pandemic.
Unlike the growth trend, the structural inflation 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 to 1980-2015), historically a major driver of inflationary trends (see chart below)
• 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
Charts of major changes in global savings and how this has historically influenced the inflation rate:
Past 70 years old, people become major consumers of capital
Regression analysis of 85 countries over 1960–2005 (Bosworth & Chodorow-Reich, 2006)
Source: Brookings, Gavekal Data/Macrobond, PwC, Konwave AG
Patterns of consumption and saving shift dramatically with age. In the US, every year from now on, some three million people will turn 70 years old.
While excess savings based on the demographic trends were still rising until 2015 (increasing global capital provider ratio, i.e. deflationary), the structural (demographic) trend has changed since and is now pointing to more inflation over the next few decades (decreasing global capital provider ratio).
After 35 years the trend in global savings has turned
Refined global CPR (GDP-weighted) vs US inflation
Source: Brookings, Gavekal Data/Macrobond, PwC, Konwave AG
Unfortunately, the world is now entering a new “dissaving” phase, as the baby boomers start to live off their past contributions into 401(k), pension plans and the like. History suggests this phase is likely to 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.
New macro super cycle and capital allocation cycle as a game changer for gold miners
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 “every-thing 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.
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.
Besides the new macro super cycle, favouring value/commodity/short-duration equities during the next years, the capital allocation cycle also points to a game changer for gold and metals miners.
The chart below confirms that super cycles in commodities are driven by the Capex cycle. Long phases of under-investment (10-15 years), as we have seen over the last 10+ years, and low participation rates of investors (after the dismal performance of the last 10+ years) are the foundation of super cycles in the commodity sector.
Source: Bloomberg, Kenneth R. French CRSP & GR Models
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 and also the capital allocation cycle point 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!
Conclusion
While we are going through a stagflation during 2022, which should lead to significant gains in the gold price and even more so in gold miners, the reality is that 2022 has so far proved to be a very difficult environment for precious metals investments.
The “technical recession” will turn into a deeper recession during the next few quarters, inflation pressure has peaked and will start to fall sharply in early 2023. Further weakness in equity and real estate markets might lead to an even quicker FED pivot than our Q1, 2023 expectation.
In the past, gold and goldminers reacted a month 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.
The 2020-2030 decade will be driven by economic stagnation/low growth and higher and more volatile inflation, i.e. stagflation. Real rates expectations will need to stay negative given the record high debt/GDP ratios. The new macro super cycle and capital allocation cycle is a game changer for gold miners, likely similar to 2000-2008, when gold miners significantly outperformed general equity markets.
Therefore, we should be close to a major turning point in gold miners, similar to late 2000, early 2016 and late 2018, when interest in gold and gold miners, positioning and sentiment were comparable to today!
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.
Walter Wehrli and Erich Meier, Konwave AG