Although it's been a volatile year for the stock market (what's new?), it's been relatively smooth sailing for physical gold and gold-mining stocks since the year began.
Year-to-date, the broad-based S&P 500 is up nearly 3%, but physical gold's spot price has jumped by 26% to its July 1 New York closing price of $1341.90 an ounce. It's been roughly two years since the lustrous precious yellow metal was trading at such heights, and it's certainly provided a boost to the mining sector as a whole. Every single gold-mining stock with a market valuation of $300 million or higher is up year-to-date and outperforming the S&P 500, with 16 of 26 gold-mining stocks up more than 104%. This is one of those rare instances where you could have literally thrown a dart and picked a winner.
Four reasons why gold is rocketing higher
However, I'm not one to blindly throw darts and hope for the best. As an investor in precious-metal mining companies, I prefer to understand the fundamental and psychological reasons behind gold prices moving higher, so I can decipher whether prices are sustainable or fleeting. From the encompassing look I've taken at the industry, I'd suggest there are four primary catalysts pushing physical gold prices higher.
1. Global uncertainty
If there's one psychological constant among buyers of gold, it's that they consider it a safe-haven investment when there's some form of U.S. or global uncertainty. When the stock market is turbulent and investors simply can't stomach the gyrations, they tend to turn to the perceived safety of gold.
In recent weeks, Brexit -- Britain's decision to leave the European Union -- has been the primary "uncertainty" catalyst. None of the 28 member nations in the EU has ever invoked Article 50 and chosen to leave, so no one is exactly certain what to expect. No one knows how drawn-out or opaque the trade negotiations will be between the U.K. and EU member countries, and there's absolutely no certainty about whether the U.K., the EU, or the developed world could be dragged into a recession because of Brexit.
2. A weakened U.S. dollar
Another reason gold has been so strong recently could be the 2016 weakness in the U.S. dollar.
Gold and the dollar tend to move opposite one another. Since most commodities are priced in U.S. dollars, a stronger currency means it takes fewer dollars to buy commodities, so commodity prices tend to fall. The opposite is true when the U.S. dollar falls in value.
The dollar itself is usually tied to the performance of the U.S. economy. A healthy and growing U.S. economy typically means the dollar increases in value. Conversely, weaker GDP or jobs growth can lead to a weaker dollar. Remember, both fourth-quarter 2015 and first-quarter 2016 U.S. GDP came in substantially weaker than expected, and May's jobs report noted that a meager 38,000 jobs were created, the lowest total in nearly six years. Recent data would suggest the U.S. economy isn't as healthy as previously suspected, which has weakened the dollar and pumped up gold's spot price.
3. Gold demand is increasing
Traditional metrics such as supply and demand also play a role in influencing gold prices. If demand for gold falls and oversupply is created, gold prices will fall. But if gold demand rises and supply isn't sufficient to meet demand, prices will likely rise. The latter is what I suspect we've been witnessing this year.
According to a World Gold Council report released in May, gold demand increased by 21% in the first quarter, which was the fastest pace on record. Private investment demand has obviously been the primary driver, with major cash inflows seen in the SPDR Gold Trust ETF (NYSEMKT:GLD). As reported by CNBC, the SPDR Gold Trust had seen $7.6 billion in cash inflows to the $34.1 billion fund by mid-May.
However, demand from central banks, the jewelry industry, and the technology sector has also generally been strong, even if Q1 2016 saw demand from central banks and the jewelry industry taper off slightly. As long as demand for gold remains robust, there are fundamental reasons for current gold spot prices to be supported.
4. Lower opportunity cost to own gold
Lastly, gold's meteoric rise has been a function of historically low bond yields in the United States and in many developed countries around the world.
As a refresher, 10-year bonds in both Japan and Germany offer negative yields, and U.S. Treasury bonds are nearing an all-time record low for yield. Since bond prices and yields are inversely related, these low yields signify that investors have been flocking to buy bonds, with some even willing to take on negative yield debt in order to avoid putting their money into the stock market. Based on data from a recently released Fitch Ratings report, $11.7 trillion in global debt currently has a negative yield attached, including $7.9 trillion in Japan alone.
Low yields are important because they push down the opportunity cost of buying gold, which is viewed as both a better store of value and a more robust growth opportunity than interest-based assets. Physical gold doesn't pay a dividend, so in order to attract private investment, yields need to remain unattractively low.
Where gold goes from here
The important question, of course, is where gold prices will head from here -- and that's a question no one can answer with any certainty. My suspicion, however, is that gold prices could head even higher.
In simple terms, we're unlikely to see investors shift their money out of gold until interest-bearing debt yields rise to a level sufficient to coerce a switch. The chances of developed countries increasing their benchmark lending rates seem incredibly slim at the moment. China's GDP growth is at a 25-year low, the U.S. is struggling to maintain 1% GDP growth and is coming off of an ugly May jobs report, and Brexit has heightened worries of a global growth slowdown in Europe. Even without Brexit, the EU was facing an uphill struggle, with Italy, Spain, Greece, and Portugal drowning in debt. With no apparent catalysts to suggest yields are going to rise anytime soon, that would mean an almost utopian scenario for physical gold.
I continue to believe that buying mining stocks, rather than investing in physical gold, is the smartest way to play gold's expected climb.
One financially solid gold miner worth considering is Goldcorp (NYSE:GG), which owns producing mines throughout North and South America, as well as the Dominican Republic. It has full ownership of eight mines, and a partial revenue share in two additional mines as of Q1 2016.
What makes Goldcorp so intriguing is its production diversity. While it is focused on gold production, its mines also contain byproduct metals that help reduce gold production costs; these include silver, copper, lead, and zinc. In Q1 alone the company produced 71.1 million pounds of zinc, 29 million pounds of lead, and 17.2 million pounds of copper. These byproducts play a big role in keeping Goldcorp's costs down, which in turn should allow its robust margins to expand as its all-in sustaining costs fall.
In my nearly 20 years of investing, this is about as perfect a scenario for the gold market as I've ever seen, and I would certainly encourage investors to take a look at gold miners as possible additions to their portfolio.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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