Gold-ilocks zone

Gold is in a sweet spot; in our view, this could be an opportune time to invest into those companies that benefit from the rising gold price, its miners. Gold prices have surged as rising inflation fears have dulled risk appetite and boosted demand for the safe-haven metal.

The recent strong price action in gold appeared to be an important inflection point, as the yellow metal advanced sharply following the news on the US consumer price index (CPI), which surged at the fastest rate since 1990. Rising inflationary forces are expected to continue, resulting in a more rapid shift in investor asset preference favouring assets such as gold.

Technicals for gold have also been favourable, with the momentum for USD-gold riding on an uptrend. Investors seeking exposure to gold can consider investing into gold miners — gold miners tend to outperform gold bullion when the price rises, and underperform if the gold price falls. Gold miners are currently trading at low valuations, which is an attractive entry point.

Gold prices on a high, bolstered by inflationary pressures

Gold prices neared a five-month high recently, following the news on the US CPI, which advanced at the fastest rate since 1990. The yellow metal gained as much as US$110 since 3 November 2021, bolstered by deepening fears of inflation and reassurances from key central banks that interest rates would remain low for the time being. Rising inflationary forces are expected to continue, resulting in a more rapid shift in investor asset preference favouring assets such as gold. We believe there is more room to run for gold.

Technicals for gold have been favourable, as explained by the technical charts below. In Chart 1, gold has advanced above the multi-month consolidation and rallied strongly above the June downtrend-line; in Chart 2, the technical analysis for NYSE Arca Gold Bugs Index (HUI) suggests that the lengthy correction since August 2020 has likely ended. Technical analysts have also stated that HUI could now be starting a strong uptrend that could reach the highs in 2011.

All this means is that technicals for gold have been very attractive, reiterating the asset class’ current sweet spot.

Chart 1: USD-Gold on an uptrend

Chart 2: NYSE Arca Gold Bugs Index (HUI) correction since August 2020 has likely ended

High gold prices in the long-term

We expect higher gold prices in the long-term. While gold is off its highs of over US$2,000 per ounce, current levels of around US$1,800 is a lofty price and one in which gold miners are able to thrive. The gold price has held its ground despite the Federal Reserve’s (Fed) tightening expectations, higher yields, US dollar strength, competition from other asset classes and persistent net selling from gold bullion ETFs. This suggests that gold is underpinned by a core of investors who see the need for investments that can help protect their wealth from unwanted risks.

Ballooning US debt also bodes favourably for gold based on history. There is a historically close correlation between gold prices and debt-to-GDP. The higher the ratio, the better it is for gold.

The US Treasury department recently reported the fiscal 2021 deficit was US$2.77 trillion, compared to the previous year’s US$3.1 trillion. The Congressional Budget Office expects the deficit will total US$1.15 trillion in 2022. With rates near zero, money is nearly free and debt service is minimalised. However, once either the Fed or the markets decide it is time for rates to rise, a debt trap might close on the US economy.

Low valuations support the case for gold miners

With gold being in this sweet spot, we believe it is an opportune time to invest in the safe-haven metal. Investors seeking exposure to gold can consider investing into gold miners, as they are currently trading at low valuations—close to five times the price-to-cash flow. Gold miners have rarely traded at this level in the last 15 years (Chart 3). More often than not, gold miners’ shares would rally hard off such low valuations. If gold remains at or around its current price levels, we expect another short-term rally for the miners purely on such low valuations. Thus, the current low valuations indicate an attractive entry point for investors.

Chart 3: Historical price-to-cash flow (P/CF) of seniors and mid-tiers

Source: RBC Capital Markets. Data as of October 2021. “Mid-Tier” and “Senior” mining companies produce, on average, approximately 0.3-1.5 million ounces and 1.5-6.0 million ounces of gold per year, respectively.

Gold stocks provide leverage to bullion

Gold equities tend to outperform gold bullion when the price rises, and underperform if the gold price falls. Although this expected relative performance may not hold during certain periods, gold equities have consistently demonstrated their effectiveness as leverage plays over the years. 

As investors become more confident that the current low multiples are not merely ‘value traps’, given their improved earnings and fundamentals, gold miners could benefit from an upward re-rating as capital flows towards value shares such as commodity-related stocks.