As of late February 2020, the major U.S. indexes are down more than 3% — and gold stocks are up more than 3%. On a day when global equities were hit hard by coronavirus (COVID-19) fears, gold and gold stocks surged to brand-new, multi-year highs. That is not a coincidence.
Gold miner profit margins are leveraged to the long-term gold price. A key metric is the miner’s all-in cost of production, and how far above that threshold the current gold price is.
For example: If gold sees a structural price increase of a few hundred dollars per ounce, a miner’s profits can double. To see how this works, imagine a gold miner with all-in production costs of $1,000 per ounce.
At a $1,500 gold price, that miner’s profit margin per ounce is $500. At $2,000, the miner’s margin goes to $1,000 — a 100% gain. If gold goes to $2,500 the margin triples.
Gold stocks are a portfolio inoculation against coronavirus and central banks in part because, when viewed as risk factors, the two components are related.
The coronavirus risk factor triggers the central bank risk factor by way of emergency rate cuts and stimulus. The rate cuts and stimulus are a threat to erode confidence in the currency and unleash the bad kind of inflation (when the value of the currency falls because investors don’t want to hold it).
Central bankers are monetary firemen. Instead of water, they spray firehoses of liquidity — showers of cheap money and stimulus — whenever a market problem threatens to become a crisis.
“Flood the system with liquidity” has been the No. 1 central bank crisis tactic since Alan Greenspan first did it in the aftermath of the 1987 market crash. Get enough crisis in the air, e.g. via coronavirus fears shutting down business and consumer markets, and you get the liquidity flood.
As the coronavirus outbreak takes another step closer to becoming a global pandemic, investors are adjusting their expectations to account for non-rosy scenarios. They are realizing the outbreak is likely to get worse, not better, and that the worst may be yet to come.
With a major outbreak in Italy, and 50,000 Italians quarantined in various northern towns, Western investors are also beginning to realize “coronavirus can happen here.” This is causing a sell-off based on fears of economic slowdown and the coming hit to earnings.
Traders are also wagering that central banks will step up. As the coronavirus outbreak worsens, the odds improve for additional interest rate cuts from the Federal Reserve, or a new round of emergency stimulus, or both.
Such actions would add to the U.S. debt pile and devalue the official paper currency — actions that are negative for the dollar, but good for gold and gold stocks.
At the same time, long-term bond yields are hitting all-time lows as investors pile into U.S. treasuries. The trouble with treasuries, though, is that bonds could get destroyed if inflation returns suddenly.
Gold stocks were already well-positioned even before the coronavirus arrived. That was due to the exploding debt and deficit situation in the United States, not to mention global debt levels surging above $250 trillion. When debt levels explode, the risk is that inflation and currency printing will follow.
If fiat currencies are worth less in the coming months because central bankers everywhere (not just the United States) are manning the printing press, gold and gold stocks should thrive.
Then, too, smart money managers are always on the lookout for non-correlated asset bets. If an asset has a tendency to go up when other things are going down, having that asset in the portfolio can dampen volatility and smooth returns, even if the asset itself is volatile.
As the events of this week are proving out, gold and gold stocks have that anti-correlation tendency. Their price performance can zig to the upside when stocks are zagging to the downside. That, too, makes gold stocks an excellent portfolio inoculation against coronavirus and central banks.
