Whether this is your first year as an investor or you've been working your way toward retirement for decades, there's simply nothing that could have prepared you for the level of disruption caused by the coronavirus disease 2019 (COVID-19) pandemic.
During the first quarter, the broad-based S&P 500 imploded, losing 34% of its value in less than five weeks. This was followed in the second quarter by the strongest quarterly rally for equities since 1998. Some industries are teetering on bankruptcy (airlines, oil and gas), while others are rocketing to new highs seemingly every day (tech stocks). It's been volatile and chaotic, to say the least.
A solid case can be made for gold at $3,000
It's also been a highly rewarding year for investors who own physical gold or (in nearly every instance) gold stocks. After closing out 2019 at $1,519.50 an ounce, the price of gold has climbed well past $2,000 an ounce this week, pushing the lustrous metal's year-to-date gain to almost 35%. For context, that tops the return for all of the major U.S. equity indexes in 2020.
The question is, how high could the price of gold climb?
If you ask me, $3,000 is a very reasonable expectation. It might sound outrageously high, considering the slow pace at which precious metals usually move, but there have never been more catalysts at the sails of physical gold in history.
We've never seen global bond yields this depressed
To begin with, global bond yields have been plummeting for years. At one point last August, approximately $17 trillion in global bond yields were negative. This is to say that investors were purchasing bonds that would pay them less than the principal upon maturity. In instances where investors were able to secure a positive-yielding bond, the return is often so nominally low that it has little-to-no chance of outpacing inflation over the long run.
For example, the U.S. 10-year and 30-year Treasury bonds are currently yielding close to 0.5% and 1.2%, respectively. The 10-year is a fraction away from hitting an all-time low yield, with the 30-year not all that far away from a record-low yield of its own. Investors who purchase these T-bonds will generate a positive nominal return but are liable to see a negative real-money return as inflation eats up all of their nominal gains.
We've simply never seen global bond yields this anemic for such a sustained period of time. Income seekers have few safe paths to safely make money or even store their cash to fend off inflation. That's what makes gold so appealing.
You see, physical gold doesn't offer a yield. Thus, when bond yields are rising, income seekers will often choose the sure thing and buy a bond. But with many bonds leading to real-money losses, gold has become the knight in shining armor for people looking to protect their capital against inflation. This has made gold arguably more attractive as an investment than it's ever been.
Unlimited QE will put historic pressure on the U.S. dollar
The other historic move we're seeing is the U.S. Federal Reserve coming to the aid of the U.S. economy and financial markets.
Typically, when the U.S. economy enters a recession, the nation's central bank will lower its federal funds rate to reduce borrowing costs and spur lending. But this alone isn't always enough to pull a struggling economy out of its trough. That's where quantitative easing comes into play.
Quantitative easing, or QE, is part of the nontraditional tool belt for the Federal Reserve. During the financial crisis a decade ago, multiple rounds of QE entailed buying mortgage-backed securities to stabilize the mortgage market, as well as purchasing Treasury bonds to help drive down yields. Remember, bond prices and bond yields have an inverse relationship. Thus, as the Fed was scooping up bonds and pushing the price of bonds higher, long-term yields were falling.
When the coronavirus pandemic kicked into high gear and the U.S. unemployment rate skyrocketed to its highest level since the Great Depression, the Fed did something never before seen: It pledged unlimited QE to prop up financial markets. This is literally a blank check to keep order in the financial markets during an historically awful period of time for the U.S. economy.
The thing is, QE tends to weigh heavily on the U.S. dollar as the money supply rapidly expands. Since the U.S. dollar and gold have an inverse relationship, historic downside pressure on the dollar should lead to record upside potential for gold.
Gold bull markets are rare but pack one heck of a punch
Another factor to consider here is that, while gold bull markets are rare, they tend to last a long time when they do take shape and deliver mind-boggling returns when they catch fire. Over the past 50 years, there have been three notable bull markets in gold.
The first was kick-started right around the time when the U.S. federal government was taken off the gold standard in 1971. Between December 1969 and January 1980, the shiny yellow metal rose from $42 an ounce to $678 an ounce, representing an increase of 1,519%.
The second bull market materialized in August of 1999 and lasted through the dot-com bubble and Great Recession. It ultimately ended 12 years later in August 2011. Over this 12-year stretch, the price of gold catapulted from $257 an ounce to more than $1,800 an ounce, marking gains of better than 600%.
The third bull market is the one you see before you right now. It began with gold hitting a low of $1,050 an ounce in late 2015, and in less than five years, the precious metal has appreciated 95%.
In each of the previous two gold rallies, it wasn't uncommon to see the price of gold more than double in a two-year stretch. Thus, plunging global bond yields coupled with unlimited QE could be the perfect storm to take gold from $1,519 at the beginning of 2020 to well over $3,000 by 2022 or sooner.
Gold stocks are where you'll want your money
While it's pretty obvious that I foresee big gains ahead for gold, I believe it's important to point out that owning physical gold isn't your best investment option. As I noted earlier, physical gold doesn't offer a yield. That's not the case with gold-mining stocks.
By purchasing individual gold stocks or mining-focused exchange-traded funds, you get to take advantage of increasing leverage from higher gold prices, and you might be able to collect a dividend in the process. Keep in mind that a $100/ounce increase in the price of gold here would net physical metal investors an extra 5%. For a mining stock, this $100 per-ounce increase might boost its operating cash flow by 10%.
There are a lot of really great names in the gold-mining industry that I'd encourage investors to acquaint themselves with. Kirkland Lake Gold (KL) is a company that frequently floats to the top of my list. Kirkland Lake has the best balance sheet in the entire industry, with $537.4 million in cash as of the end of June, and no debt. It doubled its dividend earlier this year, repurchased $379.8 million worth of its own stock, and is sporting an all-in sustaining cost (AISC) of just $751 per ounce. Essentially, Kirkland Lake Gold is working with a nearly $1,300 cash operating margin per ounce above its AISC at the moment.
Yamana Gold (AUY -0.53%) continues to crush production figures, as well. Yamana has brought new production assets online in recent years and improved the output potential of the flagship Canadian Malartic mine, in which it owns a 50% stake. Over the past five years, Canadian Malartic's annual gold output has risen by about 50,000 ounces, with Yamana reducing its overall net debt from more than $1.7 billion to $768 million, as of June 2020. By next year, Yamana's gold equivalent ounce (GEO) production should jump by a double-digit percentage to north of 1 million GEO.
Long story short, the operating efficiency of gold stocks has been improving for years, and the macro catalysts for physical gold are historically strong. It's just a matter of time before gold stocks start wildly outpacing the gains of the broader stock market.