Thesis
It has been well-known (within the mining community) that the gold mining shares have under-performed the gold price for most of the past deade, and particularly post-covid during a huge run-up in gold prices; this disparity is attributed to the inflationary costs of production, which have appreciated inline with gold prices, thus perceived to have kept operating margins flat.
As we enter 2025, many industry pundits are optimistic that the gap may be closed in coming years as production costs are now under control with improvements in efficiency; furthermore, there are arguments that the permiting, regulatory process will accelerate due to the tarriff war and emphasis on re-shoring manufacturing.
Although the mining sector (based on GDX ETF) has had a strong rally in the past year, the sector is trading below it’s level in 2010, when Gold was $1200 per ounce. The mining sector has been out-of-flavour for over a decade, as institutional investors have focused on the high growth technology stocks.
As we enter a new era of potentially strong physical gold demand, many value investors feel that the mining sector could be entering a long-term bull market. Many of the top-tier producers are well run companies that have tightened their operations these difficult years, and are now with low-debt and positive cash flow. There could be a golden opportunity in the miners.
The BRICs Coalition
I am not a “gold bug” and I do not have any material gold holdings. I’m of the opinion that there are other assets which are “gold-like” in terms of as a hedge against currency debasement.
However, I do love geopolitics and I am intrigued by the possible thesis that there is a coalition among the BRICS nations, particularly China and Russia, to move away from pricing trade in USD towards a gold-backed currency.
On this topic, I’m influenced by analyst, Simon Hunt, who suggests that China and Russia have been stockpiling gold for decades. He estimates that they collectively hold 54,000 tonnes of gold, which would provide the foundation for a new international financial system back by hard assets.
According to the World Gold Council, the total tonnes of gold to have been mined throughout history are estimated at 216,265 tonnes. This would indicate that China-Russian holdings are over 25 percent of global stockpile, and valued at over $US 6 trillion.
Anyway, I only raise this thesis as one possible explanation for the recent surge in gold prices. I know there are other theories, but the above is as plausible as any.
Commodity Life Cycle
To be candid, I’m skeptical of gold prices and see a possible bubble forming. Yes, the world’s financial system seems incredibly unstable, which would justify a flight to gold, but there are many other inconsistencies in my view.
Although some analysts have suggested were may be entering another commodity supercycle, similar to 2002-2012 period, it should be recognized that we have extremely different demographics and geopolitical issues than 20 years ago. During that particular cycle, gold and the commodity sector both appreciated 4x.
Gold vs Commodity Stocks (Since 2001)
But, that was a unique period in history, fueled by the rapid growth of China, which led the huge commodity consumption boom. This was a once in a lifetime window, and was the driving factor in the appreciation of commodities, particularly in the 2005-2007 period. China’s consumption of concrete alone could never be repeated.
The commodity sector is currently below the peaks of 2007, and has largely traded in range for the past 5 years and, in my view, global consumption peaked years ago with demographics.
Gold vs Commodity Stocks (Since 2018)
Thus, in addition to consideration of the gold mining sector, we should also consider if the recent rally in gold will eventual lift up the entire commodity sector. Commodities, too, have historically been a preservation of wealth.
Impact of a Correction in Gold
I am currently feeling a little deja-vu with Gold’s trajectory and Oil’s rise in 2006/07. At that time, I do recall few, if any, were bearish on oil prices, and Goldman did have a price forecast of $200.
Although I do feel its more likely high gold prices are here to stay, I am concerned that taking a position in the gold miners if we were to observe a correction in the gold prices, to say the $2500 range.
It’s been a very long time since we’ve observed a material pullback in gold prices. The last period was 2012-2014 when gold declined by 40 percent. The gold miners, during this period, suffered greater declines.
However, the correction in the gold prices during that period reflected an overall correction on the commodity sector. Thus, the gold miners are often characterized as being more impacted to a correction in the commodity market. I believe this reflects that gold miners are typically characterized as leveraged plays on gold.
Anyway, I do like the economics of the gold miners; I’m just slighly bearish on gold because the typical gold investors is in their ‘golden’ years (it’s very unusual to find a gold bull under the age of 50).
I would thus advise to view an allocation into the miners based on its own merits, and I’d be more concerned about the impact of a strong correction in the gold prices on the mining sector.
Perspective on Commodities
The real disparity that is emerging is the gap between the gold miners and the commodity sector. This is unusual and was not observed in the previous cycle.
Year to date the gold miners have had a good run of 30 percent increase, while the commodity majors are down 5 percent. Although understandable given the run-up in gold, its a material deviation.
Year-to-Date Gold Miners Out-performance
Although I have indicated my view of peak consumption, I think it would be very unlikely to see a sustained deviation in gold miners over the rest of the commodity spectrum.
With this in mind, I am much more inclined to purchase high-quality commodity producers, and hedge with the major gold miners.