Gold Price on the Verge of a $2,000 Resurgence?
In an unexpected turn of events, large-cap gold stocks have outperformed the precious metal itself this year, despite a downturn in gold prices. This anomaly, as noted by portfolio manager and gold strategist Joe Foster of VanEck, is largely due to a change in US monetary policy.
The gold rally in the second quarter came to an abrupt end in June, primarily due to discussions about reducing bond purchases and the possibility of early interest rate increases. These subtle shifts in policy caused a rise in real interest rates, reducing gold's appeal as a zero-yield asset and leading to a decline in gold prices.
Despite the ongoing inflation concerns and geopolitical uncertainty, higher real interest rates raise the opportunity cost of holding gold, which does not pay interest or dividends, contributing to the rapid reversal in gold's price rally. This explanation is consistent with market dynamics observed historically and noted by gold strategists like Joe Foster, who emphasize the sensitivity of gold prices to changes in real interest rates rather than nominal rates or inflation alone.
The US dollar, a dominant factor influencing gold, also played a significant role in this shift. Following the Fed's announcement, the gold price fell by 5.1 percent in the three days that followed.
However, it's important to note that despite the recent losses, the gold mining sector remains operationally and financially in great shape. Profit margins for gold mining companies are significant, and they generate substantial free cash flow. This financial strength may allow gold mining companies to increase the return for shareholders in the form of dividends and share buybacks.
Moreover, the unusual performance of large-cap gold stocks may be attributed to a catch-up game due to lagging behind gold last year despite a phenomenal year for the precious metal. Factors such as supply chain bottlenecks, labor shortages, commodity prices at multi-year highs, accelerating global growth, trillions of dollars in US fiscal spending, and increasing demand for many metals due to the global energy transition may contribute to higher inflation expectations in the long run.
Excess liquidity in the gold mining sector would be used responsibly to fund projects with lower risk and higher returns. If the strength of the US dollar wanes and the current inflation level persists, the precious metal could potentially trend towards 2,000 US dollars by the end of the year.
Despite some recovery during June, the gold price ended the month at around 1,770 US dollars per fine ounce, resulting in a monthly loss of about 7 percent. Investors are advised to focus on the Fed's monetary outlook, as the development of interest rates and the US dollar is likely to continue to influence the direction of gold.
For those interested in investing in gold, there is a list of all equity funds and ETFs in the category of precious metals available.
Gold mining companies, despite recent losses, remain operationally and financially strong, with significant profit margins and substantial free cash flow, potentially allowing them to return more to shareholders through dividends and share buybacks.
The enhanced financial strength of gold mining companies might offset the recent underperformance of gold itself, as investors may find appeal in these companies' other investment opportunities within the sector, such as equities and ETFs focused on precious metals.
