The broad-based S&P 500 hit a fresh all-time closing high on Friday, but you'd hardly know it given how volatile the stock market has been over the past year and a half. We've had three major swoons (last summer, the beginning of 2016, and post-Brexit) in which U.S. stocks were clobbered, only to see the indexes regain their losses and then get stuck in a holding pattern once again.
But this has not been the case for physical gold, which has been seemingly unstoppable since the beginning of the year. After closing at $1060.90 an ounce on Dec. 31, 2015, physical gold has rallied more than $300 an ounce to close at $1,365.40 as of Friday, July 8. That's a gain of 29% for you math-phobic people.
The year-to-date gains for miners that produce gold have been even more incredible. Of the 28 gold-mining stocks with a market valuation of at least $300 million, every last one is higher for the year and outperforming the S&P 500. What's more, 20 of the 28 have at least doubled, with 10 of the 28 having tripled in value (or more). We don't say this often, but you could have literally thrown a dart at gold miners in 2016 and picked a winner.
Three reasons why $2,000 gold is a real possibility
Yet these gains are not simply occurring by chance. There are genuine forces behind gold's ascent that could keep it plugging higher. While I won't forecast a specific timeframe, I am willing to make the bold suggestion that in the near-to-intermediate-term, physical gold prices could very well hit $2,000 an ounce. This would present upside in spot gold of another 46%, which in turn could mean even bigger gains for mining companies that've been cutting costs and boosting production in only their highest-yielding mines.
Here are three reasons why my confidence is growing that $2,000 gold is a real possibility and not just some white noise you hear on an infomercial late at night.
1. Declining global yields
If I were ranking these reasons in order of importance, I can't overstate enough just how big a deal declining global yields are for physical gold.
Think about it this way: if you had a choice between a near-guaranteed debt instrument that was yielding 5% and a physical store of value that paid no dividend, which would you choose? More often than not, most investors are going to go with the debt instrument, because there's a high opportunity cost to giving up a near-guaranteed 5% yield (which should top inflation) to invest in gold, which has no yield.
Now let's switch things up. Assume I offered you the choice of purchasing a debt instrument with a 1% yield or putting your money into gold -- which would you choose? Chances are investors are going to turn to gold, since they're not missing out on much of a return by investing in bonds. Plus, investing in any bond with a 2% or lower yield could mean losing out to inflation, and thus losing purchasing power with your money.
This latter scenario perfectly describes the choice millions of investors appears to be making around the world. The 10-year bonds in both Japan and Germany are in negative-yield territory, and 10-year Treasury yields in the U.S. are now below 1.4%. Even with a strengthening U.S. dollar against the euro and pound -- a stronger dollar usually means lower gold prices -- gold seemingly can't be stopped with the opportunity cost of owning gold precipitously dropping. Until it's "worth" owning bonds, gold could continue to march higher.
2. Increased demand for gold
Secondly, we've seen a genuine increase in the demand for physical gold. Don't forget that, buried beneath every emotional purchase or sale, there are actual supply and demand metrics that can influence where gold heads next.
In both 2014 and 2015, electronic-traded funds (ETFs) saw a net outflow of investments, which in turn meant holding less physical gold. Gold withdrawals from ETFs totaled 183.6 tonnes in 2014 and 128.3 tonnes in 2015. However, according to the World Gold Council's Gold Demand Trends Q1 2016 report, released in mid-May, gold inflows resulted in the uptake of 363.7 tonnes of gold. Just to put this in perspective, we saw more inflows during a single quarter than we'd amassed in outflows in the entire two previous years combined!
Gold demand is being buoyed by private investment as you'd expect, but we're also witnessing relatively strong demand from global central banks, the jewelry industry, and even the technology sector. Demand will continue to play an important role in gold's possible ascent.
3. Uncertainty surrounding U.S. elections and Brexit
Finally, uncertainty continues to play a role. Gold has always been considered something of a safe-haven investment to park your money into when global growth prospects are uncertain, and the past couple of months have been no exception.
Across the pond, no one is exactly sure what will happen with Britain's exit from the European Union, known as "Brexit." The U.S. stock market's latest rebound could suggest that Brexit fears have been overstated, but certain pundits believe it could throw the U.K. or EU into a mild recession. Since there's no precedence to a country leaving the EU, there's obviously some angst among investors regarding what'll happen next.
That same uncertainty can be seen in the U.S. presidential election, which is about as uncharted as we've ever seen. The possibility that a non-career politician (Donald Trump) could be in the Oval Office come January 2017 is a big unknown for the U.S. economy and stock market.
Put simply, uncertainty begets higher gold prices.
Gold miners to consider
Of course, the smartest thing you can do as an investor isn't to invest in physical gold, but to pick out gold miners that could outperform. Remember, mining stocks give you the potential of share price appreciation as well as, in some instances, a dividend.
I'd suggest focusing your attention on miners that have the lowest all-in sustaining costs (AISC), best margins, or are generally cheaper than their peers.
In terms of AISC (an all-encompassing measure of the costs it takes to keep the lights on), the clear leader is Barrick Gold (NYSE:ABX). Based on its updated Q1 results, Barrick is on track to report full-year AISC of between $760 an ounce and $810 an ounce, meaning the midpoint of its guidance is nearing $600 below the current spot price of gold. Aside from focusing on just its top ore grade mines, Barrick has made big strides in lowering its debt. It repaid $3.1 billion in debt in 2015, and it's on track to repay $2 billion in 2016. It has an intermediate goal of getting its long-term debt under $5 billion, and it's about halfway there. Less debt means lower interest expenses and more business flexibility.
Mining companies with the best margins should also be on your radar. For example, royalty and asset streaming company Royal Gold (NASDAQ:RGLD) is probably going to run circles around the industry in terms of margins. In return for upfront cash payments that mining companies use to expand or build-out mines, Royal Gold receives a long-term or life-of-mine stake in a property (most often containing gold, but Royal Gold also deals in other metals). Royal Gold pays its partners substantially below market value for the deliverable gold and pockets the difference. Thus, when gold moves higher, no company feels a more immediate positive impact than Royal Gold.
Lastly, based on valuation, Kinross Gold (NYSE:KGC) could be worth a look. When looking at the 20 largest gold miners by market valuation, Kinross was valued at the lowest price to future cash flow per share. Kinross has certainly had its fair share of problems, such as its ill-timed purchase of Red Back Mining for $7.1 billion in 2010, which ultimately resulted in more than $5.5 billion in writedowns. However, expansion at the Tasiast Mine in Mauritania, the key asset acquired in this purchase, which is expected to cost $728 million, should lead to a 50% boost in ore production to 12,000 tonnes per day by the first quarter of 2018. This expansion is going to nearly halve Kinross' cash costs at the mine, and it should provide a major profit boost.
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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