The Path Ahead for Gold and Silver
What a time we live in.
We fight over toilet paper and bags of rice. More and more people want to ‘bump’ elbows as a way of greeting each other.
Random businesses that asked for my email address are sending emails, telling me how they’re looking after their staff.
But there’s good news too. Apparently they also care about my wellbeing, and would like to offer me a special 25% off to help me through this difficult time…
A lot has changed in three weeks.
Perhaps there’s more to come.
We’re still yet to see a sign that the stock market falls are over. Although in saying that, both the S&P 500 and the Dow Jones gained a little overnight. The ASX may have a good day.
Of course as I wrote yesterday, there’s still a lot to process.The economic damage isn’t fully known. China’s double-digit falls across multiple sectors is one clue as to how big the impact will be…
Nonetheless, it won’t be bad news forever.
Central banks have taken rates to zero. So, cash at the bank won’t earn you anything.
Global stimulus measures are underway. Meaning there’s a mad scramble to create money which will reinflate asset prices…so the attached debts don’t get bigger than the value of things.
All of this will mean investors are forced to get back into the markets if they want to grow their wealth.
Lucky for us, the enormous market thumping could present investors with incredible opportunities with gold and silver stocks in the near future.
Well, I’ll hand you over to Jim today. He explains the correlation between physical precious metals price and stocks.
Then on Monday, let’s start digging around the market for a few examples.
Until next time,
The Path Ahead for Gold and Silver
Two of the questions I am asked most frequently are: ‘Why do gold and silver mining stocks not rally when the precious metals are rallying?’ and ‘Why do silver prices not rally when gold is rallying?’ Put differently, why do miners lag the metals, and why does silver lag gold?
Generally, silver and gold mining stocks do follow the precious metal’s prices, but with a lag.
The way it works is that gold bullion rallies first in US dollar terms.
Once the gold rally is sustained, gold stocks will follow.
Once the gold and gold mining stock rallies are confirmed, silver tags along.
It takes time, but gold will not be in a sustained rally without some positive reaction by silver.
Source: Hard Money Trader
Your editor in a precious metals vault near Zurich, Switzerland. The walls are covered in brown paper in order not to reveal security devices. The small gold bar in my hand weighs one kilo (2.2 pounds). The silver ingots weigh 1,000 ounces each (62.5 pounds). At today’s market, the gold bar is worth about US$56,000. The much larger silver ingots are worth about US$16,000 each. That gives some idea of the relative value of gold and silver by weight. Still, silver is second only to gold as an ‘in demand’ precious metal.
The reason for the lag between precious metals and miners is that miners need time to raise capital, do feasibility studies, drill core samples, and expand production.
Gold and silver mines have existing output, but that output is often sold forward or investors have already priced that output into the stock price.
The boost in the stock price comes from expanded production and new reserves, both of which take time.
It’s also important to bear in mind that there are relatively few pure gold or pure silver plays in the mining sector.
Gold and silver veins are often comingled in the ore.
It’s true that a given mine will be predominately gold or silver, but miners typically find both metals (and others, such as copper) and benefit from price activity in both.
Once the mining stocks do start to take off, they blow past the prices of precious metals. In the long run, if gold goes up 50%, gold miners may go up 100% or 200%, or more. The same is true for silver.
US dollar and gold are rallying together
The reason for this is the gold and silver miners have embedded leverage in the form of fixed costs. Miners have both fixed costs (management, overhead, premises, leases, etc.) and variable costs (labour, transportation, milling, etc.).
When output expands, variable costs may go up, but fixed costs do not.
This means that the revenues from the marginal output drop to the bottom line faster. The stock market then applies a multiple to that (like any other stock) and the stock price explodes upward.
The best time to buy gold and silver mining stocks is after the bullion rally has begun, but before the mining stock rally takes off.
That could be right now.
From a monetary policy perspective, gold and silver prices often move inversely to real interest rates and to dollar strength.
So, a lower real interest rate and a weaker US dollar generally produce a higher dollar price for precious metals.
But there are important exceptions to this.
One exception is when there is a global capital flight to quality. In that situation, investors around the world just want safe-haven assets. Those include US Treasury Notes and gold and silver bullion.
In those situations, the US dollar can get stronger and precious metals can rally at the same time.
That’s the situation we’re in today. The world is nervous about China and the coronavirus and also concerned about a recession in Europe.
The result is that global assets are fleeing to the US, and that means precious metals and US Treasuries rally in tandem.
This situation is likely to prevail for a sustained period because the coronavirus is far from contained and the full extent of the economic damage abroad is just now coming to light.
The trend is intact
Our view is that the gold and silver rally is here now, and the mining stock rally is coming soon.
This will happen even as the US dollar and US Treasury Notes rally too.
All three rallies are driven by hot money inflows to the US.
Of course, the US dollar gets stronger as capital floods into dollar assets, but the US dollar prices of gold and silver go up too.
What impact will the double whammy of a coronavirus pandemic and economic contraction have on precious metals and mining stocks in the coming weeks?
Right now my analysis is telling me that gold and silver prices are highly correlated (with some lags).
The rally in gold will continue, which means silver is in line for significant gains as well.
Chart 1 — Relative price of silver (blue, right scale) & gold (orange, left scale) March 2019–20
Source: Thomson Reuters Eikon
The correlation in gold and silver prices is apparent from Chart 1 (above).
However, there was some divergence beginning in January 2020 as silver lagged the gold rally.
The divergence came into sharp contrast when the prices of both metals fell abruptly on 28 February.
Gold fell from US$1,660 per ounce to US$1,575 per ounce.
At the same time, silver fell from US$18.62 per ounce to US$16.52 per ounce.
The gold decline was 5.1%, while silver fell 11.3%.
This divergence is consistent with our view that gold leads the way and silver lags behind on the upside and downside.
It also reflects the fact that gold is pure money (it’s not good for much else), but silver is both a form of money and an important industrial input in many manufacturing processes (especially automotive and electronics).
The coronavirus fear trade helps gold and silver, but the economic slowdown associated with the virus is a major headwind for silver.
That said, the long-term correlation is strong, and silver should resume its rise provided the gold rally continues.
All the best,