The unusually powerful move in gold, this year, up 46.53%, suggests a new investment regime with decade long implications. This investment paradigm shift is challenging traditional allocations like the Modern Portfolio Theory’s — 60% equities and 40% bond allocation — which has grown increasingly obsolete since the early 1980s. Today, portfolio allocations including 10% gold by Bridgewater’s Ray Dalio or approaching 25% gold by DoubleLine’s Jeffrey Gundlach are gaining in popularity. Based on the chart below, allocations to gold, through gold ETFs, could increase four-fold to match the 2009-11 peak levels and provide an attractive expected return profile for investors.
Source: TheGoldenportfolio.com
We anticipate increased asset allocations by individual and institutional investors as well as persistent central bank purchases of gold will support a strong multiyear or decade long bull market in precious metals and their miners. While current overbought conditions in gold and gold miners suggest a pullback is due, this letter will show valuation, and macroeconomic conditions support a secular bull market for gold, silver, and mining stocks is at hand. Consequently, it is prudent for investors to consider a tactical portfolio allocation to the monetary metal investment complex just as institutional investors increased allocations to venture capital and private equity to optimize portfolio asset allocations in recent decades.
The Valuation Case for Gold Miners: Gold mining stocks are coming out of a 14-year bear market. With the rise in the price of gold, earnings prospects have reversed for this asset class dramatically. The chart below by Crescat Capital shows how inexpensive gold mining stocks are compared to large capitalization technology stocks today. The trailing 12 months (TTM) PE on the technology stocks is 38.2x. The trailing PE for gold mining stocks is 16.2x. The earnings per share growth rate for technology stocks is 23.9%, but that is well below the 129.4% average growth rate for mining stocks. Furthermore, if you compare the PE to growth rate or PEG of the two sector samples, technology is trading at a 1.6 PEG versus and gold miners valued at a PEG of 0.13. The PEG valuation differential is twelve-fold in favor of gold miners.
The year-to-date chart below of the Technology Select Sector SPDR Fund (XLK), up 22%, versus the VanEck Gold Miners ETF (GDX), up 127%, shows the extraordinary outperformance of gold miners versus technology stocks. Despite the huge return differential in gold miners this year, what is surprizing is how that large valuation gap persists.
The Gold Miner to Gold Lead Lag:
When gold prices start to rise, it takes time for the benefit of the higher metal price to translate through to earnings and into stock prices. It also takes time for capital markets to realize this is an industry or sector trend. The chart below shows that gold mining stocks are outperforming gold, and the gold miner to gold relationship is rising toward levels not seen since 2006. For this reason, gold miners should continue to outperform gold until this ratio returns to the 0.2 to 0.3 ratio that was normal in the early 2000s. The upward trendline break, is a positive turning or inflection point suggesting a more favorable investment environment for gold miners.
Despite the powerful returns posted in gold stocks year-to-date, the rise in the price of gold has so helped earnings for gold miners, their valuations have not been stretched. The chart below by Tavi Costa shows that gold miner shares prices have moved in line with the appreciation of gold year-to-date. We believe that the cycle in gold mining stocks will end when gold miners’ performance exceeds gold’s performance, and that, we think, may take years.
We also believe that smaller gold mining companies are lagging the performance of larger gold miners. That differential is shown in the chart below of the ratio between larger gold miners and smaller gold miners.
All the valuation differentials are captured in the chart below where gold has well outpaced the GDX and the GDXJ, and gold, gold miners and junior gold miners appear poised to move higher in the years ahead. The chart below shows SPDR Gold Shares (GLD) up 484% since May, 2006, the VanEck Gold Miner ETF (GDX) is up only 98%, and the VanEck Junior Gold Miners ETF is down 8%. That suggests significant catchup rallies could occur for both gold miners and junior miners if gold simply pauses. Gold will pause when the supply of gold from gold miners exceeds gold demand. With gold mines taking around a decade to plan, engineer, approve, and finance, the sector appears to potentially have years of further upside.
Precious or Monetary Metals:
This investment paradigm shift is not limited to gold. It includes gold miners, silver, silver miners and other precious metals. Below is a chart showing four precious metals, platinum, silver, gold, and palladium, all having very strong performance this year in the range of 30% to 60%.
The chart above does not show the year-to-date precious metal miners’ performance which, in some cases, is even higher. In the 10% gold allocation recommended by Ray Dalio, he recommended a combination of the metal and miners.
Dollar Weakness:
Monetary metals like gold historically have been used as currency. Consequently, metals trade inversely to currency trends, and environments of debasing currencies are associated with monetary metal bull markets like in the 1970s. Year-to-date, the dollar is having its worst year since the 1970s. Furthermore, the chart below suggests a strong dollar trend is poised to break below an upward dollar price trend that began in 2011. This prospective dollar weakness should fuel further demand for monetary metals and their miners.
Dollar weakness is due to a lack of budgetary restraint and discipline reflected in growing deficits and growing Federal Debt. The chart below shows the growth in the fiscal deficit has ballooned to $3.1 trillion versus zero in 1971 when the dollar was linked to gold.
Foreign Central Bank Demand for Gold:
Foreign Central Banks have emerged as major buyers of gold. Since 2015, holdings of gold by foreign central banks have doubled. Gold provides a hedge against a weaker dollar to foreign buyers. Gold provides a hedge to international buyers against the debasement of paper currencies which occurs when central banks excessively print their currencies to finance their ballooning deficits. Economic historians point to the 1971 end of the Bretton Woods fixed exchange rates, when Richard Nixon suspended the convertibility of US dollars to $35/ounce gold, as a critical turning point in the international monetary system when the US dollar became a “fiat” currency.
Today, gold as a percentage of holdings, now exceeds US Treasury holdings for the first time since 1996. We believe that Foreign Central Banks will continue to buy more gold than US Treasuries further increasing demand for gold from these massive investment pools.
One factor accelerating the disintermediation of Foreign Central Bank holdings of US Treasuries into gold is the sharp decline in investment performance of 30-year US Treasuries since 2020. The 46% decline in 30-year US Treasury bond prices, charted below, underscores the reduced appeal of owning US Treasuries by Foreign Central Banks. Gold, by contrast, has been generating a solid return. This central bank asset reprioritization suggests a powerful source of gold buying that should persist for years. Ongoing budgetary struggles and the massive $37 Trillion in US debt, further weaken the appeal of US Treasuries and enhance the appeal of gold.
Ballooning Global Debt:
The chart below shows the percentage of government debt versus GDP for Japan, Singapore, Greece, US, and France. These huge government debts debase the attractiveness of each country’s currency and illustrate the broad international appeal of gold to hedge against weak or fiat currencies.
The chart below shows a trend of central bank easings underway, and this should further weaken currencies and increase demand for gold.
Silver is Catching up to Gold:
Historically, silver lags golds performance in precious metals bull markets. This lead lag relationship appears to be unfolding with silver’s recent outperformance. Below is a chart showing the cyclical undervaluation of silver to the S&P 500.
The chart below shows that silver just broke to a new all time high, and breakouts typically precede longer trend moves.
We believe that, as silver prices continue to rise, the demand for silver miners will increase. As was the case with gold, silver miners are lagging the performance of their respective precious metal. The chart below suggests a potential double in silver miners relative to silver could occur if the current ratio of silver junior miners rises toward 1.
A Sea Change In Investing:
Fundamental factors like declining interest rates are no longer propelling consistently higher equity, bond and real estate valuations. The chart below shows the Shiller CAPE ratio is at 37.9, above the 1929 peak, though modestly below 2000’s secular market peak.
In addition to equities having a near record CAPE ratio, the 1.06 trillion in margin debt shown on the chart below is at all-time highs. Peak margin debt is historically associated with rampant speculation and market peaks. Today’s peak margin debt is a credible sentiment indicator which should encourage perspicacious investments in gold, monetary metals, and commodities which, historically, are inversely correlated with stock prices.
Conclusion:
Sea changes are seemingly imperceptible yet powerful phenomena that occur due to the gravitational pull of the moon. Like sea changes, this letter highlights several powerful yet subtle investment trends which we believe have profound investment implications. We believe the unusual strength in gold reflects a multiyear investment paradigm shift that could last a decade. This paradigm shift includes silver and other precious metals as well as their miners.
Since the early 1980s, investment professionals have popularized Nobel Prize winning economists’ models which quantitatively optimized portfolios and asset allocation decisions. Since the early 1980s, the Modern Portfolio Theory popularized the 60% equities 40% bond allocation. In the decades since 1980s, alternative investments including venture capital, private equity, and real estate have been added to benchmark allocations and away from the overarching 60% equity and 40% bond benchmark. Today, investment giants like Ray Dalio and Jeffrey Gundlach are advocating 10 to 25% asset allocations to gold and gold miners.
One of the key drivers for the trend is weakness in the US dollar. Due to the ballooning $37 trillion federal deficit, and continuing budgetary struggles, we believe that the bull market in monetary metals will persist. The debasement of the US dollar is not unique. Many countries are struggling with excessive debt to GDP ratios and that supports the durability of this bullish precious metal market. Unfortunately, the ballooning and near record debt currently experienced by the United States, is not unique. Many countries including Japan, Singapore, Greece and France are similarly experiencing a slow protracted debasement of their currencies which further advances a case for a protracted monetary metal complex bull market.
Overvaluations in US stocks also supports the case for holding precious metals and their miners in investment portfolios. Furthermore, investment optimism and euphoria underscore equity market overvaluations create a vulnerability that supports reduced allocations to US equities and away from the popular but antiquated 60/40 asset allocation benchmark.
Valuations for gold miners are cheap and compelling relative to technology stocks, gold, and their historical valuations. Likewise silver miners are cheap relative to silver and historical valuations.
These factors warrant a thoughtful review of your asset mix because historic returns will lead investors toward recency biases that could prove costly, when compelling valuations and trend changes are offering compelling opportunities to perspicacious thoughtful investors.