We share our latest observations on global asset markets in relation to T8 Gold

All movements are expressed in United States (US) dollar terms, unless otherwise stated.

Gold bullion (+2.3%) strengthened during August, driven by momentum in its two key macroeconomic drivers (the yield on long-dated US Treasury notes in real terms and the US dollar). The US dollar weakened (the trade weighted US dollar index -2.3%) and Treasury yields in real terms (the nominal yield minus expected inflation) moved lower (the nominal yield on 10-year US Treasury notes fell by 13 basis points, driving the implied real yield 9 basis points lower).

Once again, economic data was interpreted as increasing the likelihood and magnitude of interest rate cuts before the end of the year (inflation decreased and unemployment increased). At the end of August, markets were pricing in a 25 basis point interest rate cut in September, a total of 100 basis points of cuts of by the end of 2024, and a total of 225 basis points of cuts by the end of 2025.

With US interest rate cuts coming into focus, financial market participants in the gold market have continued the shift to accumulate bullion. During August, exchange traded funds (ETFs) added to their gold holdings for the fourth consecutive month, which excluding the blip in gold demand from ETFs following Russia invading Ukraine in 2022, last occurred during the most recent accumulation cycle which concluded in 2020.

We should underline once more that Gold ETFs are the key swing factor in the gold market on the basis that they can contribute materially to both demand and supply, depending on whether ETFs are accumulating or liquidating. ETFs typically account for 5-10% of demand or supply within these cycles (although history has often seen individual quarters where they have accounted for 20% and in extreme cases as much as 40% of demand or supply). The cycles are driven by gold’s two key macroeconomic drivers, described above. We believe gold ETFs have entered a new accumulation cycle, which stands to be a powerful upward catalyst for the gold price. The last accumulation cycle ran for nearly 5 years up to the third quarter of 2020, averaging 10% of demand. Under a scenario of equivalent flows into ETFs and all else being more or less equal, we would expect the gold bullion price to strengthen by 25% on a 12-month view.

The price of gold bullion finished July at US$2,521 per ounce (+2.3%) and silver at US$29 per ounce (-0.5%). Both metals appear to remain in an established uptrend. Silver, often considered gold’s poorest cousin, is attracting considerable attention driven by a combination of industrial demand from the solar industry (the photovoltaic solar industry accounts for 15-20% of total demand, growing at approximately 20% per annum) and as a precious metal similar to gold bullion (silver and gold have had a nearly 0.9 correlation over the last 10 years) for investment purposes.

While the current gold price is setting new all-time highs in nominal terms (US$2,525 per ounce on 27 August) and is trading near to historic all-time highs in real terms using official inflation (US$2,533 per ounce in January 1980), we reflect that it is trading nowhere near its all-time high when adjusting for structural inflation to the cost of producing gold over this time.

Structural cost inflation in gold production is related to factors including the average grades of ore mined falling and the average depth of mines increasing over time. In addition, the mining industry has seen material cost inflation associated with meeting contemporary safety and environmental standards. None of these factors are captured in official inflation measures. The cost of energy has also increased which is only partially captured by measures of official inflation. As a result, today the marginal cost of gold production (the ninth decile of the cost curve) is approximately US$2,000 per ounce (in All-in Sustaining Cost, or AISC terms), which has increased at greater than 5% per annum since 1980 (or two percentage points above official inflation).

Adjusting for these factors, we estimate the all-time high gold price in 2023 dollars (real terms) would be approximately US$3,500 per ounce. Silver has even more potential, trading nowhere near its all-time highs in either nominal terms (nearly US$50 per ounce in 1980 and 2011), real terms (nearly $150 per ounce in January 1980), let alone adjusting for true inflation to its production cost.

Gold mining equities (+2.3%) strengthened, albeit lacking their typical beta of 2 to the gold bullion price. This was likely related to the sector’s market cap factor which makes it a subset of small cap equities on the basis that the average market capitalisation of the Gold Miners Index is approximately US$7 billion and the median is less than US$2 billion. Small caps (which are highly sensitivity to economic uncertainty) underperformed global equities during August, following two unrelated shocks which combined to significantly increase uncertainty in multiple global markets simultaneously (much weaker than expected US labour market data which increased the risk of a recession combined with the sudden unwinding of the Japanese Yen carry trade which rattled global markets).

In terms of valuations, the index of gold mining stocks remains at valuations that we believe is a roughly 25-year low in terms of discount to gold bullion (based on the spread between the spot gold price and the gold price implied by the market price of the equities). Further, we observe that gold equities have rarely been cheaper than the present time over the last 40 years.