I have met many gold bulls in the past 30 years while writing about the share market. They passionately argued that gold would soar as fiat currencies collapsed.
In fact, when I edited the old Shares in the late ‘90s and early 2000s, few magazine covers sold better than “10 hot gold stocks under $1”! The metal is a magnet for speculators.
Gold bulls are in full voice today. Coronavirus uncertainty drove gold to a record US$1,964 an ounce this week. The precious metal is up about 30% this calendar year (in US-dollar terms).
Predictably, the rally has prompted talk that gold is heading higher. Much higher if COVID-19 is not contained and US bond yields and the Greenback keep falling.
From a technical analysis (charting) perspective, US-dollar gold has broken through key resistance around US$1,900 (set in 2011). If the price convincingly holds above that level, the gold rally could have further legs in the second half of 2020.
Fundamentally, gold has several tailwinds. An acceleration in global Coronavirus cases is fuelling economic uncertainty. That is good for gold, a traditional “safe haven” in volatility.
The yield on the 10-year US Treasury Inflation Protected Securities (TIPS) is falling. Historically, gold rises as the TIPS yield falls, and vice versa. Gold is a hedge against a weakening economy.
An easing US dollar is another support. As a rule, when the US dollar falls relative to other currencies, gold tends to rise because it becomes cheaper to buy in other currencies.
The US Dollar Index tumbled in the past two months, amid COVID-19 fears, escalating US/China trade tensions and soaring US public debt. These fears pushed the index to almost its biggest monthly decline since April 201.
Also, the opportunity cost of owning gold is relatively lower given record-low interest rates. Unlike shares or property, gold bullion does not have an income stream. With rates so low, and dividends falling, that is less of an issue for gold investors right now.
So much, for gold, depends on COVID-19. If the virus takes longer than expected to contain, and US health and economic outcomes deteriorate even further, the Greenback could become a “punching bag” rather than the world’s traditional “flight-to-safety” reserve currency.
These are tectonic macro shifts. At a micro level, there is much to like about gold, principally improving efficiencies and discipline among Australian gold producers. That sector has rarely been in better shape from an efficiency, management and financial perspective.
Although gold has solid medium-term prospects, I am wary of chasing the precious metal higher from here and getting burned if its price momentum overshoots.
I have read much gold analysis this week and almost every commentary argues the metal is heading higher. That is cause for concern. Worse, we have rallying risk assets (equities) as well as a rallying defensive asset (gold). Something has to give.
My bet is gold will be the same or a little lower in a year’s time as the market focuses on production of a COVID-19 vaccine and the prospect of a rebounding global economy. Granted, that is a big call with much uncertainty. But it will not take much for traders to rush for the exits after gold’s spectacular recent gains.
Gold consolidation likely
Gold has almost reached my price target. For background, a reader asked for my view on the metal, and specifically on Northern Star Resources (NST) (which I like), at a Switzer Report webinar on July 2. Gold was about US$1,800 then.
I argued that risks to gold were on the upside and that it could reach US$2,000 an ounce this year if the US dollar fell during the November US Presidential elections.
The direction was correct but my timing was too conservative. Gold rallied faster than expected, bursting through US$1900 within weeks. It has run too far, too fast.
Also concerning is an Australian share market that looks modestly overvalued after second-quarter gains and is not adequately reflecting COVID-19 realities. This column two weeks ago outlined the case to take some profits during the rally and trim Australian equities exposure.
Buying Australian gold equities today poses a double threat; a gold price that will come back after soaring recent gains and an overvalued share market. Best to stand aside for now and wait for an inevitable share market pullback before loading up on gold equities.
Of course, speculators who latched on to gold’s rally could let their profits run further. Experienced traders know the “trend is their friend” and the gold trend is powerful.
But portfolio investors who bought into the gold rally this year, and have enjoyed strong gains, should start taking some profits. That does not mean deserting the gold sector entirely. Rather, prudently reducing exposure with gold at a record high, adding to cash and rotating to better-value sectors.
Then, looking to buy back into gold in the next few months when the rally cools.
Portfolio investors should always have some gold exposure (0-5 per cent for most), preferably through an Exchange Traded Fund (ETF) over gold bullion. A gold ETF eliminates market and company risk and a hedged version removes currency risk, providing pure bullion exposure.
Chart 1: US-dollar gold price
Silver has done even better than gold this year. The white metal has more than doubled to US$25.55 an ounce since the March 2020 low.
Like gold, silver looks overbought for now, particularly with the global economy in recession (silver is also used for industrial purposes).
The gold-to-silver ratio – the amount of silver it takes to buy an ounce of gold – hit 114 in early April. That was the time to buy silver. The ratio has fallen to 77 as silver has rallied.
That ratio mostly hovered between 70 and 80 over 2014-18. With silver attracting much more attention as gold breaks records, the ratio will ease further.
Chart 2: Gold-to-silver ratio
Although I am wary on gold and silver at current levels, and buying large-cap gold equities, some service providers to the gold sector appeal. One is laboratory provider ALS.
A record gold price will encourage more exploration and production in the sector in the next two years, boosting demand for laboratory services that analyse mineral samples.
I wrote favourably on ALS for this report in June 2019 at $7.24 a share. It almost hit $10 within eight months of that report. But like most stocks, ALS plunged during March, reaching $4.72.
ALS has since rallied to $7.94. The stock is a long way from previous highs, even though a booming gold sector – and a generally strong resource sector – should boost it.
ALS provides testing services for global mining companies in geochemistry, metallurgy, mine-site service and inspection. A gold explorer, for example, might use ALS to test exploration samples. Coal and gas explorers test samples through ALS’s energy division.
In lifesciences, ALS laboratories test environmental, food and pharmaceutical, electronics and animal health services. In industrial services, ALS provides laboratory work across industry.
ALS’ minerals division still provides almost a third of revenue and geochemistry is its biggest contributor. Gold accounts for almost half of ALS’ geochemistry sample mix.
There is a great chart on ALS’s May 27 Investor Presentation (accompanying its FY20 result, on page 22). It shows how a rising US gold price is a leading indictor for global exploration spending and average geochemistry sample flow at ALS.
Sample flow trended lower in 2019 and early 2020. If the usual pattern remains intact, sample flow should start moving higher as the gold price rises (there is a lag between the two).
Lower sample flow in the first half of FY21 is likely as COVID-19 reduces exploration and production volumes from junior miners. Or shuts down some mines in developing nations.
A higher gold move should underpin higher exploration activity in the second half of FY21 and a recovery in geochemistry sample volumes for ALS.
Outside of technology, mining has the best prospects of all sectors in the next 12-24 months. The sector is relatively less affected (operationally, at least) by COVID-19. And a record gold price and rising gold share prices will surely have miners raising capital to explore or expand.
ALS’s large exposure to the lifescience sector (51% of FY20) is another attraction. COVID-19 will surely increase long-term demand for testing services for surfaces, foods and other products.
Rising regulation and complexity in lifescience testing after COVID-19 is another long-term positive, given ALS’s scale and global position in laboratory samples.
The market is, understandably, more interested in gold miners as the metal soars. However, buying high-quality companies that “sell the picks and shovels” (or, in this case, laboratory samples) has worked well before and is a lower-risk strategy in boom markets.
ALS popped 5.6% on the day this column was written (July 29), suggesting the market is re-rating the company’s prospects in a booming gold sector.
Chart 3: ALS
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at July 29, 2020.