The past five-plus weeks have been historic in a number of ways. We've witnessed record-breaking volatility in the stock market, along with the steepest descent into bear market territory of all time. Investors have had their resolve tested like never before.
At the same time, we've observed an unprecedented response to the spread of the coronavirus disease 2019 (COVID-19), which has topped 716,000 cases worldwide, according to Johns Hopkins University, as of March 29. Within the U.S., select states have taken stringent measures to shut down all nonessential businesses, grounding economic activity to a halt. It's this uncertainty and economic stoppage that has investors on edge.
While most investment vehicles are liable to struggle in the shadow of COVID-19 (at least in the interim), it may prove to be the perfect storm of events that sends physical gold prices shooting through the roof. Having ended the previous week at $1,628 an ounce, it would not be in the least bit surprising if spot gold approached $3,000 per ounce by sometime in 2022.
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This is what a perfect scenario looks like for gold
What exactly does a "perfect storm" look like for the gold market? Let's take a closer look at the six key components.
1. The federal funds rate is back at a historic low
First off, we've seen the Federal Reserve act very aggressively on the interest rate front by lowering its federal funds target rate back to an historic low of 0% to 0.25%. While the Fed doesn't directly influence lending rates, its actions do trickle down and impact everything from credit card interest rates to the yields in savings accounts. This move back to all-time lows on the federal funds rate virtually ensures investors that they won't be able to make much guaranteed money by investing in bank CDs or other relatively safe investment vehicles.
2. Global bonds yields have plunged
We've also witnessed global bond yields plunge. Last year, as much as $17 trillion in global debt was sporting a negative yield. Even in the U.S., Treasury bond investors are only going to net a 0.67% yield on the 10-year note and a meager 1.26% on the 30-year bond, as of this past weekend. These yields likely won't even top the long-term inflation rate, leading to a real money loss of purchasing power. If investors can't even outpace the prevailing inflation rate, they're much likelier to choose gold as their preferred store of value.
3. The Fed is undertaking an historic unlimited QE program
Third, the Federal Reserve has decided to take the historic step of providing unlimited quantitative easing (QE) to support the smooth operation of the U.S. economy and market. QE involves monetary measures, such as purchasing Treasury bonds to drive down long-term yields and encourage lending, as well as buying mortgage-backed securities to buoy the housing market. As the Fed continues to throw money at the market, the expectation is that it'll put pressure on the U.S. dollar. With gold and the dollar usually moving inverse of one another, an unlimited QE would be very good for gold. Remember, gold essentially doubled within two years of the first QE announcement during the financial crisis.
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4. The VIX recently hit an all-time high
Gold has often been viewed as a safe-haven investment during times of fear. Last month, the CBOE Volatility Index, or VIX, which is commonly referred to as the "fear index," hit its highest level in history. People are panicked about the coronavirus pandemic, and fear has always seemingly played a role in pushing prices for the shiny yellow metal higher.
5. There are currently shortages of physical gold
Fifth, I think it's worth pointing out that the coronavirus crash has created a shortage of physical gold. While it's not uncommon for investors to want to snatch up gold as a hedge during stock market corrections, the steepness of the current decline in the market, coupled with the uncertainty of COVID-19 and even precious-metal mine closures (also tied to the coronavirus), has made gold a very difficult commodity to come by. And as the precious yellow metal has become scarcer, demand has only further increased. Supply and-demand economics would say that prices will continue to rise until supply increases.
6. The threat of stagflation is higher than it's been in decades
Finally, the threat of stagflation -- a situation where the inflation rate is high but economic growth is stagnant -- is probably higher right now than at any point in the past three-plus decades. The reason stagflation is such a concern is because the Fed wasn't working with a full deck prior to beginning its monetary loosening cycle. It has, historically, taken an average of 500 basis points of cuts to the federal funds rate to pull the U.S. economy out of a recession. But the Fed has already exhausted its tool chest with an aggregate of 225 basis points in cuts. Along with unlimited QE, this has the potential to causes the price of goods and services to surge, beginning in 2021, while offering no guarantee of real economic growth.
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Gold-mining stocks are going to be a smart investment holding in the years to come
While physical gold has, perhaps, never had so many positive catalysts all hit at the same time, I still wouldn't suggest that investors add the lustrous yellow metal to their portfolios. Instead, I'd encourage investors to seek out gold-mining stocks that can leverage a higher gold price into a windfall of profits.
Keep in mind that gold-mining stocks are able to pay a dividend, whereas physical gold offers no yield. Additionally, gold miners can adjust their operations to match prevailing market conditions. Public companies also publish their income statements and balance sheets on a quarterly basis, allowing for a more thorough and detailed dive than you'd get with just physical gold.
Considering that mining closures may be necessary in some countries to mitigate the impact of the coronavirus, it's important for investors to pick out gold-mining stocks that have sufficient capital and minimal debt to survive these temporary shutdowns.
My personal largest holding, SSR Mining (SSRM 5.06%), fits this bill. Inclusive of its marketable securities, SSR Mining ended 2019 with $570 million in cash, but only $288 million in debt -- $115 million of which was repaid by the end of March. Although SSR Mining shuttered its silver-focused Puna Operations in Argentina until March 31, as well as its gold-focused Seabee mine in Canada for precautionary reasons until the end of April, it has more than enough cash on hand and working capital to weather the storm.
In fact, SSR Mining's acquisition of Claude Resources in 2016 has been a godsend. The Seabee mine had, until this year, returned year after year of record production at a very low cost. At $1,600 gold, SSR Mining is likely to generate well over $2 in cash flow per share. But my suspicion is this cash flow projection soars over the next 12 to 18 months.
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But there are other cash-rich gold-mining stocks beyond what I own that should benefit. Kirkland Lake Gold (KL) and Alamos Gold (AGI 1.83%) are two names that come to mind.
Kirkland Lake Gold ended 2019 with close to $700 million in net cash, some of which has been put to use in the form of an aggressive shareholder return plan. Kirkland Lake expects to repurchase a total of 20 million shares of stock, and recently doubled its quarterly payout to $0.125 per share. Having now completed the acquisition of the Detour mine in Northern Ontario, Kirkland looks to be on track to produce in the neighborhood of 1.5 million ounces of gold annually at exceptionally low costs. A sizable uptick from the whopping $463 million in free cash flow generated from its operations last year does seem likely.
Then there's Alamos Gold, which has a little over $200 million in net cash. Similar to Kirkland Lake, Alamos generated record cash flow from its operations ($260.4 million) last year, which allowed it to double its 2019 dividend and repurchase 2.7 million shares of its stock at a cost of $11.4 million. Exceptionally low all-in sustaining costs of $951 an ounce at its three producing mines continues to drive Alamos' earnings from operations higher.
If there were ever the perfect time to own cash-rich gold-mining stocks, this is it.
