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The article below is an excerpt from our Q2 2024 commentary.
As we write, gold has surged past the $2,500 mark for the first time in history, an event that would seem to herald a golden age for gold stocks. Yet paradoxically, these stocks have seldom been cheaper. What underlies this dissonance, and what might it portend for the future?
Before delving into these questions, it’s instructive to reflect on the historical backdrop. The last great bull market in gold spanned from 1999 to 2011, during which the price of gold soared from $252 to $1,900 per ounce, an eightfold increase. After a sharp correction between 2011 and 2015, gold resumed its upward trajectory, now trading 30% above its 2011 peak. Gold equities, however, have failed to follow suit. The NYSE Arca Gold Bugs Index (HUI), a benchmark for gold stocks, languishes at 312, more than 50% below its September 2011 high. Even more striking, the HUI today is only 10% above its August 2016 level—when gold was a mere $1,300 per ounce. Meanwhile, the HUI’s earnings per share are expected to quadruple this year compared to 2016.
This disconnect between gold and gold equities is largely explained by interest rates and the behavior of central banks. Since 2020, real U.S. 10-year interest rates have climbed from -0.40% to 2.1%. Western investors, habituated to offloading gold in response to rising real rates, have acted predictably. From 2020 to 2024, gold ETFs shed 31 million ounces, or 25% of their holdings, as investors sold both bullion and equities. The largest gold stock ETF, the GDX, experienced consistent outflows amounting to nearly 20% of its assets. This is reminiscent of past cycles; between 2012 and 2015, as real rates rose from -0.20% to 0.80%, gold ETFs liquidated 36 million ounces.
Yet this rate hike cycle has a critical difference: for the first time in decades, central banks have emerged as significant buyers of gold. Between 2020 and 2024, central banks accumulated an estimated 106 million ounces of gold, more than offsetting the liquidation by Western investors. Consequently, despite the sharp rise in real interest rates, gold has nearly doubled. Unfortunately for gold mining executives, central banks are interested in gold bars, not gold shares. With no natural buyer to counteract Western selling, gold equities have been left in the dust, now trading at historically low valuations.
As contrarian value investors, we see extraordinary opportunity in this disparity and have been increasing our positions in gold equities.
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