Gold’s Anomaly: A Cautionary Tale for Investors and Gold Miners
Historically, gold has exhibited an inverse correlation with real interest rates. This relationship has been one of the strongest among asset classes. However, this relationship has broken down over the past year, leaving analysts perplexed.
This anomaly suggests one of two possibilities: either gold is significantly overvalued or the US government is on the verge of a significant monetary crisis. Regardless of which of these two scenarios is true, it has implications for gold mining stocks like those in the NYSEARCA: GDX.
Why Gold May Fall 50% Later This Year
Gold and inflation-indexed Treasury bonds, such as those in TIP, both serve as hedges against inflation. However, TIPS either pay a yield over inflation or underperform it, determined by the ‘real interest rate.’ Generally, a high real interest rate devalues gold as investors shift to bonds that offer higher post-inflation returns. Conversely, a low real interest rate makes gold more attractive.
Significantly, high real rates are the leading cause of currency appreciation compared to other currencies. Hence, with the US offering a solid ~1.9% real rate on 10-year Treasuries, the US dollar is historically strong today.
Paradoxically, gold is also relatively strong. To illustrate this, a scatter chart comparing the US dollar’s relative strength and the real interest rate on 10-year Treasury bonds shows a positive correlation. Additionally, there is a negative correlation between gold and the US dollar and real rates.
However, since 2022, gold has risen in value despite a continued rise in real interest rates. One possible explanation is that gold is rising due to inflation. To account for this, a scatter chart comparing real interest rates to the price of gold adjusted for the CPI was created. This chart showed a strong correlation (R-squared of 51%) between real rates and gold in constant ‘2024 dollars.’
This correlation suggests that gold should be closer to $1180/oz today based on the historical pattern. However, gold is currently around $2330/oz. This discrepancy raises concerns about gold’s overvaluation.
GDX Outlook Assuming Gold is Fairly Valued
If we assume that the bond market is misvalued and gold is fairly valued, then the US economy may be in a very long and slow economic depression since 2020. This view is supported by chronically low consumer and business sentiment.
If the ‘true’ real interest rate is zero, gold would be fairly valued today based on the historical pattern. However, inflation has been undercounted based on the CPI measure for at least a decade, not fully explaining the gold rate discrepancy.
More likely, the gold market may be accounting for it indirectly as investors buy gold to hedge against perceived US monetary devaluation risk, which would exacerbate inflation in the future.
If we assume gold is reacting to the real possibility that the US government faces a monetary crisis, then gold could continue to rise in value.
However, as noted regarding Newmont, this may not be bullish for gold miners.Gold miners make a profit on the difference between gold and their AISC. Yes, gold miner profits will likely return to 2021 levels in 2024, potentially temporarily benefiting GDX. However, as we have seen since 2021, gold mining costs are rising about as fast as gold.
Much gold is produced in developing countries. If the US monetary powerhouse fails, those countries may face monetary instability, leading to greater labor issues and operating struggles.
The Bottom Line
Overall, the outlook for GDX remains neutral. It has risen with gold over the last month and is just below its 2021 price range. Many will likely see their profits increase to ~2021, making GDX fairly valued based on likely profits.
Should gold continue growing, most major global gold miners are not expected to benefit much. If gold rises due to monetary instability, which appears to be the case, then that will likely result in economic and social instability that further increases gold miners’ operating costs or even the risk of asset seizure and other issues.
