Gold and precious metals mining shares are casualties of panic selling across all financial markets. The scenario is similar to what happened in 2008 during the global financial crisis (GFC). When the general selling exhausted itself in late 2008, gold and mining shares delivered superior absolute and relative performance for the following three years. We believe that this pattern is likely to repeat following this sell-off.
While COVID-19 outbreak is grabbing the headlines, the far bigger story is the deflation of financial assets that it has triggered and the resulting loss of investment confidence. Markets that had been priced for perfection must now reckon with a likely recession, soaring fiscal deficits and the very real possibility of a sustained bear market.
In our opinion, even though the economy will recover from the downturn and the health scare will prove to be temporary, financial asset valuations are unlikely to return to pre-crash manic levels. In mid-February, the Wilshire 5000 Stock Index1 traded at approximately 145% to gross domestic product (GDP),2 its second highest level since 1950, and only slightly below the 2000 peak (see Figure 1). At this writing, the ratio has fallen to 114% (as of 3/17/2020), which is still very expensive by historical standards. Valuations are driven by investor psychology, leverage and the liquidity necessary to support leverage. All three may have been critically impaired for the near to intermediate term.
Figure 1. Total U.S. Corporate Equities and U.S. GDP (1950-2020)
Source: AdvisorPerspectives.com. Data as of 3/3/2020.
If financial assets struggle, interest in gold is very likely to widen. Gold may have been caught up in the recent stampede for liquidity, but it has delivered good relative performance on a year-to-date basis; gold bullion is up 0.73% as of March 17, compared to -25.17% for the S&P 500 Index.3 The 12-month figures (as of 3/17/2020) are even more impressive: gold has returned 17.19% vs. -8.54% for the S&P 500.
On a peak-to-trough basis for the last few weeks, gold has declined roughly 12%. Other safe haven assets have experienced the same pressure. For example, the yield on 30-year U.S. Treasury bond rose from less than 1.0% to 1.5% in only a few days, a drawdown of more than 30%. What this shows is that quality assets will be sold by portfolio managers desperate to reduce leverage. Low-grade assets cannot be sold quickly enough to meet margin calls.
It was leverage that inflated valuations, not fundamental economic growth and strong year-over-year earnings. In fact, corporate pre-tax profits have been declining since Q3 2014. Figure 2 shows pretax profits on a quarterly basis since 2014.
Figure 2. U.S. Corporate Pre-Tax Profits Have Been Declining ($Billions)
Source: Federal Reserve Bank of St. Louis Economic Research. Data as of 3/16/2020.
The illusion of earnings growth that has captivated investor psychology was achieved through share buybacks and increased leverage. Growth of earnings per share, not the same as profit growth, has been juiced by financial engineering. The same can be said for returns on financial assets. The amount and location of leverage within the economy and financial markets is opaque but may well have reached high tide for many years. A post-recession economic recovery will not necessarily, and does not have to, translate into strong returns from investing in financial assets.
In popular thinking, the current U.S. administration, or the one that follows it, will pull every trick out of the bag to stimulate the economy. This belief will likely excite investors from time to time in anticipation of a rebound. Unfortunately, the financial markets are experiencing a deflationary bust that could spread to general economic activity. Public policy has all but exhausted the potential benefits of resorting to traditional monetary and fiscal solutions. The marginal benefit to economic growth from heaping on new layers of debt is capped by the law of diminishing returns, as shown by Figure 4 from Rosenberg Economics. Since 2007, global debt increased 110% vs. 46% for global GDP:
Figure 3. Global Debt vs. Global GDP ($ Trillions)
Source: Rosenberg Economics. Data as of 12/31/2019.
Central banks have few conventional tools remaining to combat credit deflation. An impotent response can be expected from new rounds of monetary stimulus, rate reductions or central bank balance sheet expansion. Global debt, public and private, measures 287% vs. global GDP ($244 trillion divided by $85 trillion). The debt burden will most assuredly grow, a post coronavirus rebound notwithstanding. The world’s debt structure is already incapable of withstanding even a minute rise in rates. More debt relative to GDP will only make matters worse. All that remains is currency destruction.
Gold has been rising for the past eighteen months side by side with a strong stock market and no inflation. Conventional wisdom said that wasn’t supposed to happen. As shown in Figure 4, gold has outperformed equities and bonds since 2000, the dawn of radical monetary experimentation by central bankers. We think gold has been sensing the endgame for Keynesian policy prescriptions, mainstream economic thinking and hyper-leveraged investment practices.
Figure 4. The Modern Era of Gold
Gold Bullion vs. Stocks, Bonds, Oil, USD (2000-2020)
For the period from 12/31/1999 to 3/16/2020, gold has provided posted an average annual return of 8.55%, compared to 5.44% for U.S. bonds, 4.44% for U.S. stocks, 0.57% for oil and -0.19% for the U.S. dollar.
Source: Bloomberg. Period from 12/31/1999 –3/16/2020.4
During the 1930s credit deflation, gold and gold mining stocks performed well in relative and absolute terms. When credit deflates, and counterparties cannot be trusted, gold is the ultimate safe asset. In the 1930s, the metal price rose, costs of producing gold declined and the miners generated strong earnings and paid handsome dividends. We believe that this is a sequence that will repeat.
At the moment, mining company valuations appear extraordinarily cheap. It is one of the few industries that will report solid year-over-year earnings gains for the remainder of this year and perhaps into the next.
Buying low is never easy but now is the time to do it.
|1||The Wilshire 5000 Total Market Index is a market-capitalization-weighted index of the market value of all US-stocks actively traded in the United States.|
|2||GDP represents the total market value of goods and services produced within the borders of a country.|
|3||The S&P 500 Index is a stock market index that tracks the stocks of 500 large-cap U.S. companies.|
|4||Gold is measured by GOLD Comdty; Bbgbarc US Agg Bond Index is measured by the Bloomberg Barclays US AggTotal Return Value Unhedged USD (LBUSTRUU Index); S&P 500 TR is measured by the SPX; Oil is measured by USCRWTIC; and the U.S. Dollar is measured by DXY Curncy. Past performance is no guarantee of future results.|
Past performance is no guarantee of future results. You cannot invest directly in an index. Investments, commentary and statements are unique and may not be reflective of investments and commentary in other strategies managed by Sprott Asset Management USA, Inc., Sprott Asset Management LP, Sprott Inc., or any other Sprott entity or affiliate. Opinions expressed in this content are those of the author and may vary widely from opinions of other Sprott affiliated Portfolio Managers or investment professionals.
This content may not be reproduced in any form, or referred to in any other publication, without acknowledgment that it was produced by Sprott Asset Management LP and a reference to sprott.com. The opinions, estimates and projections (“information”) contained within this content are solely those of Sprott Asset Management LP (“SAM LP”) or its affiliates and are subject to change without notice. SAM LP makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, SAM LP and affiliates assume no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information. SAM LP and affiliates are not under any obligation to update or keep current the information contained herein. The information should not be regarded by recipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particular circumstances. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by SAM LP or its affiliates. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. SAM LP and/or its affiliates may collectively beneficially own/control 1% or more of any class of the equity securities of the issuers mentioned in this report. SAM LP and/or its affiliates may hold short position in any class of the equity securities of the issuers mentioned in this report. During the preceding 12 months, SAM LP and/or its affiliates may have received remuneration other than normal course investment advisory or trade execution services from the issuers mentioned in this report.
The information contained herein does not constitute an offer or solicitation to anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Prospective investors who are not resident in Canada or the United States should contact their financial advisor to determine whether securities of the Funds may be lawfully sold in their jurisdiction.
The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering or tax, legal, accounting or professional advice. Readers should consult with their own accountants and/or lawyers for advice on the specific circumstances before taking any action.
© 2021 Sprott Inc. All rights reserved.
You are now leaving sprottus.com and entering a linked website.Continue
You are now leaving Sprott.com and entering a linked website. Sprott has partnered with ALPS in offering Sprott ETFs. For fact sheets, marketing materials, prospectuses, performance, expense information and other details about the ETFs, you will be directed to the ALPS/Sprott website at SprottETFs.com.Continue to Sprott Exchange Traded Funds
You are now leaving Sprott.com and entering a linked website. Sprott Asset Management is a sub-advisor for several mutual funds on behalf of Ninepoint Partners. For details on these funds, you will be directed to the Ninepoint Partners website at ninepoint.com.Continue to Ninepoint Partners