Over long stretches, the stock market is an undeniable wealth creator. But when we look at it over shorter periods, the directional movement of equities becomes a bit of a guessing game.
For instance, 2021 saw the ageless Dow Jones Industrial Average (^DJI -0.66%), broad-based S&P 500 (^GSPC -0.22%), and technology-dependent Nasdaq Composite (^IXIC -0.22%) surge to multiple all-time closing highs. In the following year, all three indexes were firmly entrenched in a bear market and produced their worst full-year returns since 2008.
Although there aren't any indicators, metrics, charts, or software that can concretely predict the directional movement of equities, there are certain indicators, metrics, and charts that have an undeniably strong track record of making these calls. One such chart, with more than 123 years of history to back it up, implies that a widely owned commodity might be on the verge of rocketing higher.
If history repeats once more, all that glitters will be gold.
Image source: Getty Images.
One ultrapopular commodity might be on the verge of a lustrous rally
Gold is one of the most-traded commodities on the planet and typically trails only Brent Crude, West Texas Intermediate Crude, and natural gas futures contracts in terms of average futures contract trading volume. It's also an investment that people typically seek out as a safe haven.
For instance, uncertainty has, historically, been one of the key reasons money has flowed into gold-backed exchange-traded funds (ETFs) and physical gold. When the stock market struggles, both new and tenured investors are going to look to other asset classes to invest in. Gold has long been viewed as a near-ideal hedge to economic uncertainty and stock market swoons, such as we experienced last year.
But if history has any say in the matter, gold could be much more than just a hedge in the coming years -- it could be poised to crush the performance of the S&P 500.
Gold is ultra cheap relative to stocks, which is what has occurred before major historic gold bull markets.
-- Jesse Colombo (@TheBubbleBubble) May 25, 2023
Via: https://t.co/eUJjsD3ZWF $GLD pic.twitter.com/jGGwlLTz1c
As you can see in the tweet above, which features research from financial institution Incrementum AG and was shared by Jesse Colombo, the director of marketing at BullionStar, physical gold has a knack for bouncing off of predictable levels when compared to the value of the S&P 500.
When back-tested to January 1900, the spot price per ounce of gold has averaged a 1.66 multiple relative to the value of the S&P 500. In other words, if the hypothetical spot price for gold is $500, the value of the S&P 500 would be about 300 (1.66 to 1).
In three previous instances when the gold-to-S&P-500 ratio bottomed well below 1, we witnessed a sizable rally in the spot price of the lustrous yellow metal. This includes:
- an increase from less than $21/oz. in 1929 to $35/oz. less than five years later (a move from $366/oz. to $792/oz. on an inflation-adjusted basis).
- a move from approximately $40/oz. in early 1969 to roughly $664/oz. by early 1980.
- a jump from about $260/oz. in 2001 to $1,770/oz. 10 years later.
With a fourth instance ongoing right now -- the gold-to-S&P-500 ratio is currently 0.47 -- history would suggest a new bull market is ready to bloom for gold.
Et tu, M2?
But it's not just the above ratio that could give gold wings in the years to come. Some tangible macroeconomic factors could also provide a sustained tailwind for its spot price.
Arguably the biggest catalyst for precious metals like gold is the movement we've witnessed in U.S. money supply.
Economists and investors pay close attention to two money supply metrics: M1 and M2.
- M1 is a measure of all coins and bills in circulation as well as things like traveler's checks. Think of M1 as money that can be spent by consumers at a moment's notice.
- M2 takes into account everything in M1 and adds money market funds, savings accounts, and certificates of deposit (CDs) of less than $100,000 held at financial institutions. In other words, it's money that can still be spent somewhat easily, but it requires a little more effort than simply reaching into your wallet.
WARNING: the Money Supply is officially contracting. 📉
-- Nick Gerli (@nickgerli1) March 8, 2023
This has only happened 4 previous times in last 150 years.
Each time a Depression with double-digit unemployment rates followed. 😬 pic.twitter.com/j3FE532oac
During the COVID-19 pandemic, the issuance of multiple rounds of stimulus checks allowed M2 to make history. In just a 12-month stretch between early 2020 and early 2021, M2 money supply expanded by 26%. Back-tested data from the U.S. Census Bureau and Federal Reserve bank of St. Louis to 1870 shows that this 26% year-over-year increase in M2 was the largest on record.
Expanding the U.S. money supply by trillions of dollars in such a short period was bound to have consequences. The historically high inflation that topped 9% in June 2022 was a direct reflection of fiscal and monetary policy actions during the pandemic. When the U.S. money supply grows, it dilutes the value of each existing dollar and makes it pricier to buy store-of-value assets, like gold.
However, declines in M2 money supply can be favorable for gold. There have only been five instances, when back-testing to 1870, when M2 money supply declined by at least 2% year over year. In four of those previous instances (all occurring between the 1870s and 1933), three depressions and a panic developed. The fifth instance, which is happening right now, features a 4.8% drop in M2 from its peak over the past year.
To be fair, the 1870s depression and panic of 1893 occurred prior to the creation of the Federal Reserve. Meanwhile, the 1921 depression and Great Depression came about shortly after the creation of the Fed. With 110 years of knowledge and data now at its disposal, the Fed is better positioned to tackle economic weakness. In short, depressions aren't nearly as likely to occur today as they were a century earlier.
Nevertheless, a decline in M2 is typically a harbinger of economic weakness to come. That's a recipe that typically favors safe-haven assets like gold.
Image source: Getty Images.
Two precious-metal stocks poised to shine if gold takes off
If we are on the precipice of a big-time bull market for gold, mining stocks, not physical gold, will make for the best investments. Mining companies can always improve their operating performances, and unlike physical gold, mining companies can pay dividends.
Two precious-metal miners, in particular, are poised to shine if history rhymes.
The first likely winner is Wheaton Precious Metals (WPM -2.88%). Wheaton actually isn't a mining company in the traditional sense -- that is, it doesn't operate mines that recover precious metals. Rather, it's a royalty company that provides up-front capital to mining businesses that want to develop new assets or expand existing mines.
In return for an up-front cash payout, Wheaton is entitled to a percentage of what's mined at a cost that's well below market. Further, many of these are life-of-mine deals, which means consistent cash flow for Wheaton Precious Metals years down the road.
NYSE: WPM
Key Data Points
During the quarter that ended in March, Wheaton's average cash cost per gold equivalent ounce (GEO) was $443. However, it was able to sell what it received from its numerous partners at an average of $1,827 per GEO. You'd struggle to find a juicier cash operating margin in the mining industry than 76%. If gold enters a runaway bull market, Wheaton's low-cost structure could allow its stock to soar.
The other gold-mining stock that can shine if gold takes off is a company that's near and dear to my heart, SSR Mining (SSRM -4.46%). I say "near and dear" because it's my largest holding by a sizable amount.
One of the biggest differences between SSR Mining and most traditional gold-mining companies is its balance sheet. SSR's management team wisely avoided overexpanding production and has maintained a healthy net cash position. This has allowed SSR to repurchase stock and initiate a dividend, which currently sits near a 2% yield.
NASDAQ: SSRM
Key Data Points
SSR Mining also has a pretty clear path to sustained annual GEO production of 700,000 ounces (or higher) throughout the entirety of the decade. Production expansion at the low-cost Copler mine in Turkey, along with additional investments in the Marigold and Seabee gold mines, should allow all-in sustaining costs to fall considerably through the middle of the decade.
Although the gold market doesn't turn on a dime, the puzzle pieces appear to be in place for the lustrous yellow metal to outperform in the years to come.
