The best reason to avoid gold just became the best reason to buy it

Dear Reader,

It’s been a while. A long while.

But UK Uncensored is back – spurred into action by a bout of coronavirus selling on global stockmarkets.

Is the ten-year old bull market in stocks finally over? Or is this just another opportunity to buy the dip?

Your new editors Kit Winder and I, Nickolai Hubble, will figure it out. At least, try to…

And our coverage begins with one of the few assets in the green…

(You may have noticed we have a brand new email address. Please ensure you add us to your contacts and whitelist us in order to make sure you don’t miss a thing and our emails land straight in your inbox without delay!)

Coronavirus doom or gold boom?

This week, James Bond, Jesus’ birthplace, 70% of Chinese small and medium businesses and HSBC’s research division in London were all laid low by coronavirus. Alongside stocks, of course.

We have seen the relief rallies that central bankers are supposed to trigger too. But they don’t seem to stick any more.

This despite steady quantitative easing (QE), rate cuts, cooperation and coordination from central banks, and everything else that used to work so well.

That should scare investors. Far more than the actual plunge in stocks. Because QE is the dirty little secret behind the bull market that began in 2009. It was the fuel of the rally.

If that fuel no longer drives stocks higher then… the plunge could be a big one.

Not everything is going wrong though. Gold is up. At least it was eventually.

Gold began last week at almost $1,690 – an eight-year high. And then it fell below $1,570 on Friday in an accelerated plunge.

Social media lit up with confused, angry and panicked gold investors. What had gone wrong?

Isn’t gold supposed to be a hedge? Isn’t it supposed to go up during a crisis?

At that point, gold was still up substantially year to date, unlike stocks. But that didn’t stop the anguish.

A week later – this week – and it turned out to be a storm in a teacup. Gold staged a comeback while stocks stayed down for the count, twitching violently.

What made it interesting is that the comeback happened despite stocks continuing to struggle. That’s a reversal of the previous week’s correlation where both fell.

On Tuesday we saw a drop in stocks and a rise in gold as the Federal Reserve’s rate cuts underwhelmed. And again on Wednesday as other central banks added more stimulus.

But here’s the kicker. The US-listed gold stock exchange-traded fund (ETF) GDX surged 5% on Tuesday, while other stocks plunged. Not only is the gold price rising in the face of falling stockmarkets, but gold stocks are up too.

And they did it again on Thursday – GDX was up while the S&P 500 took a hit.

This chart shows the split, with GDX in blue and the S&P 500 in red.

Source: Yahoo Finance

By the time you read this, I expect it’ll be happening again as US markets open.

This is a whole new phase of the gold bull market. A phase where even gold stocks are capable of diverging from the rest of the stockmarket.

Why did they pull that off?

For a simple reason, if you ask me. Earnings season is drawing near. And gold companies must be raking it in thanks to the higher gold prices.

It’s tough to argue with earnings, even for gold sceptics.

Heck, dividend investors might even be buying gold stocks at this point.

Last week’s action was the test for gold investors. Whether they’re too flappable and skittish for the volatility of a gold bull market. And whether short-term shocks would push them out of positions.

This week was the reward for holding on.

That sort of action is common at the beginning of any bull market. Bitcoin believers refer to it as “the halvening” because bitcoin’s periodic 50% price crashes make gold and gold stocks look boring by comparison.

The next phase of the bull market will feature gold stocks outperforming, instead of just the precious metal, as the cash flow impact of the gold price begins to play out.

Remember, once the gold price is above a company’s cost of production, each increase in the price translates to profit. That’s a form of leverage to the gold price for investors.

But back to the gold shakeout last week, for a moment.

There’s a great deal of irony in what happened. Gold investors are supposed to be long term, patient and unaffected by short-term volatility. They should be aware of gold’s odd price structure. That the price is set in the futures market amongst the speculators, in the short term.

In other words, those who panicked last week should’ve known better. But many didn’t. And they’re likely to be tested again.

Of course the key question in all this remains whether the gold price will continue to rise. But one event on Thursday suggested it will. My colleague and desk-mate Boaz Shoshan calls it the Golden Doughnut.

Treasury inflation protected securities (TIPS) are loans to the US government that pay an inflation-adjusted return. The yield on 30-year TIPS went to 0% on Thursday, suggesting that, adjusted for inflation, you will not make any money by lending to the US government for 30 years.

That is the Golden Zero and it’s the first time it’s happened. Why golden?

The strongest argument against holding the safe haven gold as an investment is that it doesn’t pay any interest. You’re better off in government bonds – a safe haven that does pay interest.

Well, with government bonds no longer paying any interest, adjusted for inflation, you might as well own gold. And that’s where the demand for gold will come from.

Gold stocks are however the optimal mix of the two. They do pay returns in the form of dividends. And that’s why I expect them to boom.

Thanks for reading, we’ll be back in touch next week.

Best wishes,

Nick Hubble
Editor, UK Uncensored

1 Comment
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